George L. Davis, Jr. Egon Zehnder, Boston
The Next Stage of Globalization
The Convergence of Corporate Governance Practices
Good governance has gone global. Over the past several decades we’ve witnessed the increasing international harmonization of standards in information technology, trade practices, and other critical areas of transnational commerce. Today, we’re seeing a global convergence of good corporate governance practices. Although this latest global convergence has been little remarked, it is bringing far-reaching changes and challenges to corporate boards around the world.
Perhaps this phenomenon has gone relatively unnoticed because, unlike the convergence of other global standards, it has not been brought about by sweeping international agreements or international bodies like the World Trade Organization. Instead, a variety of forces, some global and some specific to particular countries and regions, are coming together to create a de facto standard that boards in more and more countries are moving toward. As a result, striking structural differences in boards, like the two-tier system in Germany versus the one-tier system of the Anglo-Saxon world, may obscure what are in fact striking similarities in good governance aims and practices.
The drive for good governance has been under way in many countries for a decade or more. Perhaps most importantly, countries are beginning to adopt more universally recognized good governance practices in order to make themselves more attractive to investors. In addition, shareholder activists, especially large institutional shareholders like pension funds and labor unions, have pushed relentlessly for more influence with boards. In some locales, the drive for good governance has gained momentum from corporate scandals, problems of product liability, and controversial commercial practices. Increasingly, board members in some jurisdictions find themselves the objects of lawsuits or the subject of stricter rules of director liability. Most recently, the convergence of governance practices has been given a global push by the worldwide financial crisis. The result of all of these forces has been a steady stream, and lately a flood, of legislation and regulation in countries around the world – new rules that may have their origins in national or regional concerns, but that taken together are bringing governance practices into line everywhere.
It’s not all a matter of coercion, however. In our work conducting appraisals of board competencies and helping fill board seats for leading global companies, we find a widespread and deep commitment to good corporate governance. Many boards embrace the challenges of good corporate governance and seek to adhere to the highest standards, and individual board members are motivated by a desire to find the best way to fulfill their responsibilities.
But whether responding to external pressure or proactively leading the way in corporate governance, boards around the world are seeing their characteristics, composition, and practices converge in at least seven key areas:
- Transparency: In the past, the work of boards remained largely behind the scenes. However, with investors and other stakeholders demanding a far higher level of transparency, boards in many countries will increasingly be required to disclose more information about such issues as executive compensation, diversity, succession planning, and risk.
- Diversity: Forward-looking boards have expanded the idea of diversity beyond gender and ethnic diversity to include diverse professional experiences, areas of expertise, nationalities, and diversity of thought, which they believe will bring greater business value to their deliberations. It is this broader idea of diversity that is converging among leading companies globally and it is likely to have far greater impact on the performance of boards than arbitrary quotas. Meanwhile, the initial impetus for gender and ethnic diversity continues. Since Norway passed a law in 2002 requiring that 40 percent of all board seats at state-owned and publicly listed companies be held by women, Spain and the Netherlands have followed suit and now Belgium, the UK, Germany, France and Sweden are considering similar laws. In the US, the Securities and Exchange Commission (SEC) recently began requiring public companies to disclose whether, and how, they consider diversity in identifying directors. But the SEC requirement neither defines diversity nor establishes numbers, which suggests that companies under its jurisdiction may consider the far broader notion of diversity that is now gaining ground in many locales.
- Global directors: Boards of global companies and companies seeking to earn significantly more revenue from non-domestic markets, are increasingly embracing one aspect of diversity in particular – diversity of nationality. They want the knowledge of unfamiliar cultures, markets and operating conditions that board members with experience in other geographies can bring – and the superior performance that results. In the US, for example, Egon Zehnder’s International Global Board Index found that companies where foreign nationals represent one-third or more of the board outperform the rest of the S&P 500. Countries like the UK, Belgium, Holland, Switzerland, and Sweden, with a high proportion of large companies relative to the size of their populations and economies, long ago recognized the need to seek markets beyond their borders and their companies began to welcome international directors onto their boards. In addition, the BRIC (Brazil, Russia, India, China) countries, which will account for a large percentage of growth in the global economy in the next several years, are increasingly being targeted for directorships in European countries. This internationalization of boards not only contributes to better business performance but also encourages the convergence of good governance itself by cross-pollinating best practices from different regions.
- Risk management: Following the global economic crisis, we have seen a clear trend toward adding expertise in risk management to boards – not only in financial services companies but in companies of all kinds. This is part of a larger trend, which predates the economic crisis, to raise the level of specialist expertise on boards in many areas such as information technology and finance.
- Splitting of the Chairman/CEO role: Boards are often dominated by a single individual, particularly in the US where the CEO and Chairman are frequently one and the same person. Increasingly the two roles are now being assigned to two different people, as in the two-tiered German and Dutch models. And in the same spirit, many companies instead of splitting the roles are adopting the practice of appointing a non-executive Lead Director, who presides over board meetings and fills many board leadership functions.
- Independence: The move toward splitting the roles of Chairman and CEO is part of a larger trend toward more independence of the board from management. Many boards now have a higher percentage of non-executive directors, and many key committees – such as Audit, Nominating & Governance, and Compensation – are chaired by independent directors. On many boards, independent directors regularly hold private meetings without the CEO or other executives present.
- Professionalization: Increasing board independence, the heightened emphasis on specific expertise, greater director liability, and the push for improved governance have all combined to ‘professionalize’ the role of directors. The days are long gone when the board met a few times a year to rubber stamp the actions of management. Today, around the world, directors exercise far more rigorous oversight, and they are increasingly held more strictly accountable for results. They spend far more time preparing between meetings. They meet more often and for longer periods of time. And, as individual board committees have taken on more specific and demanding areas of responsibility, their work has become more critical in decision-making. The financial scandals in the first part of the decade greatly expanded the work of Audit and Finance committees. The global drive for good corporate governance, including closer scrutiny of board composition, has given new prominence to Nominating & Governance committees. Controversy over executive pay has put increased pressure on Compensation committees. Within committees, members may work on specialized topics like sustainability, risk management, and succession planning. All of this work requires an unprecedented degree of professionalism, dedication, and fine-grained knowledge on the part of today’s board member.
In sum, the standards that boards are expected to meet in all of these key areas will continue to rise. To do so, boards will need to analyze their composition in light of these increasingly universal requirements, review the company’s governance processes and practices, and refine them where necessary. It will require a conscious and comprehensive effort on the part of boards, but the world now expects no less.
George L. Davis, Jr. has been a consultant with the Boston office of Egon Zehnder since 1997. He is co-leader of the global Board Consulting Practice and a member of the firm’s Executive Committee.
Berthold Leube has been a consultant with the Berlin office of Egon Zehnder since 2002. He is a member of the Financial Services Practice and heads up the activities of the Board Consulting Practice in Germany.