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."


According to the WSJ, "[c]limate has muscled to the top of business worries." Consulting firm McKinsey suggests that climate change will "need to feature as a major factor in decisions. For companies, this will mean taking climate considerations into account when looking at capital allocation, development of products or services, and supply chain management, among others." Although the direct impact may be local, "it can have knock-on effects across regions and sectors, through interconnected socioeconomic and financial systems." For example, infrastructure could be destroyed or disrupted by hazards including heat, wind or flooding, leading to a decline in the services or a rise in the cost, with knock-on effects on other sectors that rely on these infrastructure assets. Climate change could also have a substantial impact on global supply chains. (See this PubCo post.)

Corporate purpose. Another key trend identified by RRA is a shift away from the shareholder primacy theory. 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."


You might recall that, in August, the Business Roundtable announced the adoption of a completely new Statement on the Purpose of a Corporation, signed by 181 well-known, high-powered CEOs. According to the press release, beginning in 1997, the Business Roundtable's Principles of Corporate Governance advocated the theory of "shareholder primacy—that corporations exist principally to serve shareholders"—and relegated the interests of any other stakeholders to positions that were strictly "derivative of the duty to stockholders." The new Statement superseded previous statements and "more accurately reflects [the Business Roundtable's] commitment to a free market economy that serves all Americans. This statement represents only one element of Business Roundtable's work to ensure more inclusive prosperity, and we are continuing to challenge ourselves to do more."

The new Statement followed a 2019 letter from Fink promoting "corporate purpose" and advocating the need for corporations to fill the vacuum left by dysfunctional political institutions: "Unnerved by fundamental economic changes and the failure of government to provide lasting solutions, society is increasingly looking to companies, both public and private, to address pressing social and economic issues. These issues range from protecting the environment to retirement to gender and racial inequality, among others." (See this PubCo post.)

Shareholder primacy was not always the prevalent theory, argued Professor William Lazonick in "Profits without Prosperity," published in the September 2014 Harvard Business Review:

"From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth—what [he calls] 'sustainable prosperity.' This pattern began to break down in the late 1970s, giving way to a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality." [emphasis added]. (See this PubCo post.) The shift to shareholder primacy has been widely attributed to the development of the "shareholder preeminence theory" by the Chicago school of economists, beginning in the 1970s, with economist Milton Friedman famously arguing that the only "social responsibility of business is to increase its profits." Subsequently, two other economists published a paper characterizing shareholders as "'principals' who hired executives and board members as 'agents.' In other words, when you are an executive or corporate director, you work for the shareholders." (See this PubCo post.)

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."


What is human capital management? According to SASB, HCM "addresses the management of a company's human resources (employees and individual contractors) as key assets to delivering long-term value. It includes issues—such as labor practices, employee health and safety and employee engagement, diversity and inclusion—that affect the productivity of employees, management of labor relations, and management of the health and safety of employees and the ability to create a safety culture." (See this PubCo post.)

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.


The SEC's proposal seeks to refocus the current disclosure by replacing the existing requirement to disclose only the number of employees with a requirement to disclose, to the extent material, a "description of the registrant's human capital resources, including in such description any human capital measures or objectives that management focuses on in managing the business (such as, depending on the nature of the registrant's business and workforce, measures or objectives that address the attraction, development, and retention of personnel)." The exact measures or objectives discussed in a company's disclosure may change over time and vary with the industry. The objective, according to the SEC, is to allow investors "to better understand and evaluate this company resource and to see through the eyes of management how this resource is managed." (See this PubCo post.) The proposal follows the submission in 2017 of a petition for rulemaking regarding HCM disclosure by the Human Capital Management Coalition, a group of 25 institutional investors with more than $2.8 trillion in assets under management. (See this PubCo post.)

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."


And boards should not lose sight of California's board gender diversity law, which requires that public companies (defined as corporations listed on major U.S. stock exchanges) that have principal executive offices located in California, no matter where they are incorporated, have a minimum of one woman on its board of directors by the close of 2019. That minimum increases to two by December 31, 2021, if the corporation has five directors, and to three women directors if the corporation has six or more directors. (See this PubCo post.)

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."

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