Digital Age Requires a New Governance Model

By Raj Gupta

As the digital revolution transforms every aspect of our lives – from how we create and consume products and services, to how we communicate, entertain and relate to one another – the implications for chief executives and boards of directors are almost immeasurable.

There are some undeniable trends that I see affecting every global industry and company. These include the rapid changes in the business environment driven by technology; globalization of customers and competitors; increased regulatory and trade complexity; the concentration of shareholdings and rise of shareholder activism; and the global war for skilled talent.

These trends are rapidly changing the role of corporate boards and their relationship with the CEO and management.

By necessity, the role of the board is evolving from one of “oversight” to a "partnership." This does not imply the board is a CEO’s buddy - board independence is at all times critical. But this shift requires a diverse set of directors who possess the right skillsets, life and professional experiences, and the willingness to invest significant time engaging in the business.

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While oversight, which is essentially compliance and execution, remains an important part of a board’s responsibilities, the true “value add” for effective boards will come from working in partnership with management.

This new model entails some key components: CEO succession and talent acquisition; risk management; shareholder outreach; true pay for performance; and the creation of long-term value.

• The most critical responsibility of a board is the selection of a CEO, as well as planning and assuring an orderly CEO succession. The CEO succession process is a responsibility that lies uniquely with the board and should be supplemented with relevant input from the incumbent.

Another key area boards must be engaged in is talent acquisition and assessment below the CEO level. This includes regular reviews of succession planning, exposure to high potential employees, evaluation of recruiting strategies and external assessment of internal candidates.

The partnership model also includes active engagement with strategy development. In fulfilling this responsibility, a board’s diversity of talent and perspective can be indispensable to management. While it is the responsibility of the CEO and management team to develop and articulate a coherent corporate strategy, they need to incorporate both internal and external input on the various options. The board must be afforded the opportunity to provide input to the strategy, ensuring that there are clear and measurable milestones. It must also be regularly updated on the progress of implementation, providing fine-tuning in response to an ever-changing external environment. The best measure of this is how effectively the company balances the allocation of capital between shareholder returns and investing in growth.

• Another critical area for boards to concentrate on is identifying risks and developing mitigation plans.

Public companies face an ever-increasing set of external threats including cyber security, reputational threats, litigation and political risks, all of which demand that there is a robust defensive planning process with response plans. This involves much more than having a crisis plan in a binder that can be pulled off the shelf at the eleventh hour.

Rather, there must be regular reviews of risk conditions and the planning process to ensure the right advisors, decision makers and information sources are in place to act swiftly and decisively in the event a risk turns into a crisis. In my many years of board experience, I have learned it is the initial responses in the very first phases of a crisis that will ultimately dictate the long-term outcomes – both good and bad.

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• The next important part of the partnership model is shareholder outreach, which is one of the best ways boards can build confidence that they are looking after shareholders’ interests. Given that the top 25 investment institutions hold more than 50 percent of the shares of most public companies, engaging with investors and having strong governance is essential.

Boards must think like an “activist” to identify and understand their own vulnerabilities in conjunction with proactive outreach to directly hear investor’s perspectives on governance and strategy. This has to be a well-managed activity with two or three board members who are well prepared to represent the board on the important issues at hand.

I would submit that a non-executive chair or lead director, the chair of the Compensation Committee and chair of the Nominating/Governance Committee make a good alliance for this purpose. Done well, this process of self-reflection and engagement has the potential to serve as a powerful deterrent to activist shareholders, though ultimately, only if these good governance practices translate into good performance.

• Next, there is true pay for performance, which is creating a compensation structure that encourages and rewards ethical behavior and acting in the interests of shareholders, with both a near- and long-term point of view.

Establishing the right performance metrics with the right level of stretch is a key requirement in encouraging a high-performance ethical culture. This is not a system that rewards short-term thinking for maximizing returns in a short window of time.

That is a formula for long-term value destruction due to unintended consequences and operational damage that can be inflicted by short-term thinking and bad practices. Rather, true visionary leadership and strategy requires finding that delicate balance of near-term operational discipline coupled with long-term investment, resulting in sustainable, profitable growth to the benefit of all stakeholders.

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• Finally, it is very important there is full alignment among the investors, directors, and management on the critical priorities to create long-term value. To ensure this requires that directors have sufficient "skin in the game." In a private company, this occurs naturally as the majority of directors are investors. In my view, this can be achieved by a modest change in the way public company directors are compensated. Typically compensation in public companies is 60 percent equity and 40 percent cash, awarded annually with equity vesting after a year. Awarding five-year equity upfront (vesting 1/5th annually), with a requirement to hold until retiring from the board will strongly align directors’ and investors’ interests. There may well be other ways to achieve the same objective.

Effective boards meet these increased demands by having a highly engaged independent executive or non-executive chair or lead independent director. They set the board agenda in consultation with the CEO, lead executive sessions at the start and towards the end of each board meeting, set board priorities above and beyond oversight and assure the ongoing proactive evolution of the board to include directors with the right skills and experiences, as well as diversity in terms of thought, race, gender, global experiences and other demographics. They also assure that assessments of board and individual director performance are objective and provide meaningful and appropriate feedback.

While board positions certainly offer an excellent opportunity to both contribute and learn, the rapidly changing nature of expectations in today’s global business climate requires one to conduct appropriate diligence on the company, its CEO, and board, before accepting a board position. The Board acting as a true partner in the business is the future of effective governance. Working together, effective boards with accountable and empowered management can create substantial and lasting value to the benefit of all, even in this highly dynamic digital age.

Rajiv L. Gupta is Chairman of Delphi Automotive PLC, Chairman of Avantor Inc. and board member of Arconic Inc.,The Vanguard Group and IRI.