The “Old” Board Governance Model Needs to Change

Corporate boards are under increasing attack by investors, shareholders and the public. In the aftermath of corporate legal train wrecks – such as Wells Fargo, Volkswagen Emissions, General Motors, JPMorgan, 1MDB – and increased demand for sustainability, ESG and other shareholder public policy objectives, corporate board members have a significant target on their backs.

Corporate governance is at a critical juncture. The old-line, New York law firm classic boardroom legal defense efforts will continue, but clinging to corporate law principles (while well-settled) ignores the impact of a fast-growing trend and desire for accountability. In these circumstances, the New York corporate lawyers will continue to earn their large fees, engage in protracted defense litigation and ultimately slow down the pace of change.

Such a narrow, but lucrative view of corporate board governance, however, ignores the fast-growing trend demanding change and innovation. The rise of young corporate leaders will demand change, and eventually the law itself will be subject to change. Given our country’s history, if there’s anything we all can agree on, it is that the law eventually changes in relation to social movements, pressure and trends.

For years, corporate boards have followed and clung to a few basic and very limited “rules” to protect themselves:

1. The business judgment rule protects board members from any consequence for decisions based on information provided by management relating to broad governance principles relating to ESG (environmental, sustainability and governance), sustainability and shareholder/investor “activism” issues;
2. Directors cannot be held liable for decisions alleged to be “grossly negligent,” but can be held liable for a knowing breach of a duty; and
3. Directors are protected from liability for false or incomplete public disclosures where they rely on information and advice from senior management, company counsel and other advisors.

To those cynical governance observers, these principles provide not only a shield, but an escape from responsibility and basic duties. Corporate directors do not have to (and should not have to) engage in detailed, intensive reviews of recommendations, reports and advice. However, directors have to apply their expertise and common sense through probing inquiries, information review and follow-up when addressing important issues.

A broader approach to governance, not just a narrow legal one, is now imperative. The Business Roundtable’s August 2019 broad statement of corporate purposes was an important reflection of this trend. The major index funds – BlackRock, State Street and Vanguard and other investors have emphasized a broader and longer-term approach to corporate purposes beyond short-term quarterly growth aimed at increasing shareholder wealth.  Resolving these two different perspectives is difficult and, in time, will tilt toward a broader, long-term approach to corporate purposes.

The old model of corporate decision-making is about to undergo significant change. Board members who resist such change will face significant pressure from real and substantial stakeholders. New York corporate attorneys will resist this trend and advise corporate boards to cling to the old model and the legal rules that have protected board members from liability.

At bottom, corporate boards have to understand the interests of multiple stakeholders without a singular focus on quarterly profits. A longer-term view of sustainability does not mean that long-term growth and profits is the sole focus of corporate boards; rather, corporate boards have to look at interests of other stakeholders, including employees, vendors/suppliers, the community and the public.

A broad definition of corporate purpose can involve numerous objectives – among them: profits, competitive gains, attracting a productive workforce, avoiding or reducing environmental harms from operations, increasing prosperity to benefit the community and establishing a reputation as an ethical and responsible corporate citizen. To this end, corporate board members have to acknowledge the new set of expectations from shareholders, employees, customers, suppliers, communities and government entities.

Such a perspective will quickly identify important issues on a variety of social topics: climate change, wealth inequality, wages, training, health care and retirement, supply chain performance and avoidance of trafficking, slavery and child labor. Working with management, the board has to identify stakeholder interests, measure the corporate impact or performance in these areas and prioritize objectives and measurement of performance on an ongoing basis.

This article was republished with permission from Michael Volkov’s blog, Corruption, Crime & Compliance.