Boards, Governance and Value Creation
In practice, however, resource allocation is extremely difficult, especially when it involves comparing businesses with different strategic characteristics, investments with long time horizons, or innovative projects with uncertain pay-offs—to name a few of the common challenges. The difficulty is compounded by pressures from shareholders with differing objectives, time horizons, and tolerance for risk. As a consequence many managers give short shrift to strategic and human complexities when making resource allocation decisions and instead rely on standard financial tools such as discounted cash flow analysis.
Thus, factors such as an increase in carbon emissions or potential risks to customers or employees are not typically considered in making these decisions. In recent decades, this process and the resulting allocation of resources have come in for heightened scrutiny. The growth in share buybacks in recent years has also been cited as further evidence of a bias toward short-term shareholders and declining corporate re-investment though academic opinion on this point is divided.
Whatever the verdict on the significance of short-termism in the aggregate—which also remains a matter of debate among academics—surveys indicate that for many boards and managers the tensions between near-term expectations and longer-term needs are acute. Such tensions are to some extent inherent in the job of governing, but the debate about short-termism suggests that the tensions can perhaps be better managed and somewhat mitigated through better oversight over strategy, more clarity about time frames, and improved communication with investors. But the debate also suggests the need for more radical innovation in how companies develop strategy and allocate resources.
A first step is for boards to better understand these processes, the time frames that guide them, and the extent to which they include human, environmental, and social considerations.
These matters raise questions of business judgment that boards and executives will increasingly be expected to address. Corporate performance.
As fiduciaries, boards of directors are expected to keep a close watch on corporate performance. But what is corporate performance and how should it be assessed? Providers of capital, the prototypical users, seek performance information so that they can compare across opportunities to identify the best use of their capital and ensure effective ongoing stewardship of their investments.
Other users may have different purposes — for example, a lender wanting to ensure timely payment of interest and principal, or a corporate center allocating resources to various divisions. The board itself needs this information to assess the success of corporate strategy or to decide on executive compensation. Still others, such as a potential customer or employee, or a local community deciding whether to grant a zoning variance will likely have yet other needs. Such a variety of sources of demand for corporate performance information means that no one definition of performance or a simple measurement system will suffice.
When it comes to corporate financial performance, investors typically look to s tock price measures such as Total Shareholder Return or TSR and accounting numbers such as Return on Equity or Return on Assets. TSR, which is a direct measure of how much shareholders have benefitted, has become a significant determinant of executive compensation especially in the US. TSR provides an easy benchmark of relative performance across companies and over time. However, if stock price is driven by biases of investors especially of those who are short-term shareholders, then TSR is less useful as a metric of long-term value creation, the elusive benchmark against which any performance metric ought to be assessed.
Measures based on accounting metrics are less subject to investor horizon concerns but are considered backward looking and subject to managerial manipulation. Moreover, accounting rules codified as generally accepted accounting principles or GAAP are slow to keep pace with rapid changes in business, technology, and organizational complexity. As a result, more managers are turning to alternative non-GAAP measures, such as adjusted income or cash operating return on assets, in an attempt to better describe the unique aspects of the business that are not captured by the conventional metrics.
Differing time horizons for assessing performance add further complexity to the challenge. Many stakeholders demand periodic assessment and reporting of performance, but operating and investment cycles do not conveniently correlate with calendar quarters or years. What then is the appropriate horizon? In most jurisdictions, listed companies are legally required to report their financial performance annually, and in many cases quarterly or at least half-yearly. But other users, such as boards of directors, have the option of measuring and compensating performance over longer horizons.
Recognizing that no single metric whether based on stock price or summary accounting metrics or time horizon, is sufficient to capture the richness of business outcomes, some companies have adopted a dashboard approach based on ideas such as the balanced score card, for example, to measure interim outcomes rather than the ultimate objectives. This approach measures shorter-term indicators that will eventually lead to better overall outcomes. For instance, a company that relies on a strategy of long-term technological superiority, can measure and reward more immediate outcomes such as patent filings or the hiring and training of knowledge workers.
This approach requires managers to develop a causal theory of drivers of performance, and to measure and motivate achievement of the intermediate drivers of performance that should eventually lead to long-term success. In addition to measuring financial performance, companies are also being asked to measure their social and environmental performance on various dimensions ranging from diversity and inclusion, to customer privacy and supply chain conditions, to human rights and carbon emissions.
Although some academic studies purport to show the financial benefits of strong social or environmental performance, the overall evidence of a linkage is inconclusive and the matter is unlikely to be resolved by academic studies given the many ways of measuring these different types of performance and the many factors that influence how companies perform on each of them. The Sustainability Accounting Standards Board SASB , for instance, is seeking to determine which environmental and social factors are financially material on an industry-by-industry basis.
Corporate performance measurement remains an exciting area of innovation and debate, both in terms of the appropriate measures and the appropriate horizon of measurement. Companies are experimenting with broader disclosure of strategy and drivers of long-term success while recognizing that investors and other stakeholders often prefer summary metrics and shorter-term outcomes as a way of identifying trouble early.
Corporate oversight. Traditionally, it was seen as quite limited. In the s, the duty was expanded to require boards to ensure that management set up information and control systems to monitor for such violations, but still with an emphasis on accounting and financial misconduct. Indeed, boards today are expected to oversee an extensive and ever-expanding menu of risks. In the wake of the financial crisis, the boards of banks and financial institutions were taken to task for paying insufficient attention to excessive financial risk. The recent spate of behavioral complaints against senior corporate leaders has raised questions about board oversight of executive conduct and caught numerous boards off guard.
On a different front, various companies have suffered serious breaches of cybersecurity that have exposed a lack of preparedness and resulted in significant reputational damage; others have been tripped up by data privacy concerns and are facing political and user backlash.
- Boards, Governance and Value Creation: The Human Side of Corporate Governance.
- All Through the Night;
- Morten Huse - Google Scholar Citations.
- 1st Samuel: An exposition of 1st Samuel (The 66 Books).
Environmental disasters, labor abuses in the supply chain, mistreatment of customers—these are other examples of the new breed of risk management issues that are consuming the attention of boards. The broadening menu of risks has created a challenge for traditional practices of internal controls and is testing the ability of boards to provide adequate oversight. Since the financial crisis, the internal audit and risk management functions have received significantly greater attention especially in banks and financial institutions.
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All large banks in the U. Similarly, in other industries, boards have adopted new risk oversight protocols or enlarged the mandate of the audit committee beyond traditional audit and internal control matters to include the oversight of other risks. Some, like the banks, have created a dedicated risk committee while others have assigned particular categories of risk oversight to various other committees, such as conduct risk to an ethics and compliance committee, or supply chain risk to a sustainability committee.
Boards have also sought to educate themselves about cyber risk and made cyber a defined area of board oversight. Recurring cases of large-scale employee participation in reckless or illegal behavior—such as the mortgage-lending scandals leading up to the financial crisis or the diesel emissions scandals at several large auto makers—have created a growing recognition that organizational culture is a key factor in driving risk. This insight has led to efforts by various supervisory bodies and professional organizations to educate boards about organizational culture. Overseeing risk thus requires boards to go well beyond their traditional monitoring activities and to develop new ways of gauging the pulse of the organization.
This task is being aided through advances in data science and computing abilities that are allowing digital compliance tools and predictive analytic capabilities to be used to help with risk management, especially in banks and financial institutions. Most directors today recognize the importance of robust oversight, but it is unclear whether boards, as they are currently constituted and operate, are up to the task.
The increasing size and complexity of companies, the expanding array of risk areas, and the difficulty boards have in getting the information needed to exercise effective oversight all bode poorly for a positive answer to this question. To be sure, other institutions, some internal and some external to the organization, also provide oversight.
Boards, governance and value creation : the human side of corporate governance - EconBiz
Large investors, proxy advisors, regulators, the media, NGOs, the general public—all play a role. However, it is doubtful that these institutions can substitute for boards and, indeed, it could be argued that these institutions can be effective only if boards themselves are effective.
In the coming years, boards can expect increasing pressure to strengthen their risk oversight capabilities while at the same time driving the kind of entrepreneurial innovation needed for sustainable growth and profitability. Corporate reporting. Boards of directors play an important role in ensuring that investors and the public receive accurate and timely information about corporate activities and performance. In recent years, boards and audit committees have faced an increasingly complex set of reporting and disclosure challenges.
One set of challenges has arisen from the globalization of capital flows. By , countries had adopted IFRS, albeit to different degrees, and the IASB had become the recognized accounting standard setting institution for most of the world. In the interim, boards and auditors face vexing issues that arise, for example, when a company that reports under IFRS acquires a company that reports under GAAP. Another set of challenges has arisen from the spread of mark-to-market or fair value accounting for a growing number of asset classes.
In contrast to historical cost accounting, the dominant methodology for measuring value, fair value accounting aims to measure the value of corporate resources and value created using current market prices. Fair value accounting originated as a way of making financial statement numbers more timely and relevant, especially the values reported for tradable securities and the many new financial products developed in recent years to manage risk, such as hedges, forward contracts, futures, swaps, and options. However, fair value accounting also gives managers greater discretion to determine values, particularly when market prices are not readily available, and thus makes greater demands on auditors and audit committees to ensure the integrity of reported figures.
Similar issues are posed by the emergence of new business models arising from rapid innovations in technology. The challenges are perhaps most apparent in the medical sciences e. New business models enabled by these technologies—online platforms and bundled products hosted in the cloud, among others—are outpacing the development of performance measures that capture their true economic value. Companies have responded by producing measurements and reporting figures that arguably better reflect their businesses but that are inconsistent with conventional reporting metrics.
While non-conventional measures may have merit, they also obviate the benefits of uniform measurement rules, make it more difficult for users to draw meaningful conclusions, and call for greater vigilance on the part of boards and audit committees. In parallel with these new challenges, companies have faced heightened demands to provide various types of non-financial information, especially about their social and environmental impacts.
Although there is no legally mandated framework for such reporting, many companies have adopted the standards put forth by the Global Reporting Initiative GRI which cover a wide range of topics from human rights and workplace equity to environmental compliance, anti-corruption efforts, and customer privacy. The proliferation of sustainability topics has prompted various efforts to narrow and systematize the field.
The long history of generally accepted accounting principles suggests that it is likely to be some time before sustainability or integrated reporting becomes standardized and widely accepted as a part of doing business. In the meantime, boards and companies will face difficult decisions about reporting and disclosure on both financial and non-financial matters.
Although the merits of transparency are evident, and the availability of accurate and timely information is crucial for the effective functioning of markets and society, gathering and reporting on corporate-wide information can be costly. As demands for more extensive reporting and disclosure continue to escalate, boards and companies will be challenged to find more efficient and more meaningful ways to respond. Lynn S. Paine is the John G. Corporate governance. Paine Suraj Srinivasan. The questions that boards, managers, and shareholders should be asking. Executive Summary How corporations govern themselves has become a matter of broad public interest in recent decades.
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