Corporate Governance and the Board -- What Works Best

1. Corporate Governance and the Board -- What Works Best Financial Executives Summit Scottsdale May 7, 2001 Richard M. Steinberg Leader, Corporate Governance

2. Why We Care About Corporate Governance Impetus for the PwC Study

3. Why All the Interest? • Corporate upheavals, failures, misstated financial reports • Increased regulatory scrutiny -- Blue Ribbon Committee-based new SEC and listing rules • Shareholder activism -- institutional investors (CalPERS, TIAA-CREF), social investors (PIRC) • Legal liability -- Federal Sentencing Guidelines, Caremark 3

4. Organizational Drivers - The US • Corporate Director’s Guidebook, American Bar Association, 1994 • Standards issued by investor groups such as CalPERS & TIAA-CREF • Statement on Corporate Governance, Business Round Table, 1997 • Principles of Corporate Governance: Analysis and Recommendations, American Law Institute, 1994 • National Association of Corporate Directors • SEC, NYSE, NASD and AMEX adopted new audit committee rules in December 1999 4

5. Canada -- Dey (’94), CICA (‘95,’99) UK -- Cadbury (’92), Hampel (‘98), Turnbull (’99) France -- Vienot (’95,’99) The Netherlands -- Peters (’97) Belgium -- Cardon (’98) Germany -- KonTraG (’98) South Africa -- King (’94) Australia -- Bosch (’95) Hong Kong -- Hong Kong Exchange (’99) Japan -- Principles (’97) OECD -- Advisory Group (’98) Around the World 5

6. The StudyCorporate Governance and the Board -- What Works Best Conducted, written: PricewaterhouseCoopers Sponsored, published: Institute of Internal Auditors Research Foundation

7. Our Objective To help boards of directors improve the effectiveness of their oversight, thereby enabling them to enhance shareholder value 7

8. Methodology • Reviewed over 200 publications • Survey • 72 directors, thought leaders in 9 countries • In-person, in-depth interviews • 28 directors in 5 countries • PricewaterhouseCoopers’ experience in serving boards 8

9. Corporate Governance Responsibilities Board Responsibilities • Corporate strategy and planning • Risk management • Values & ethics -- tone at the top • Measuring and monitoring performance • Major transactions • Management evaluation, compensation and succession • Communications & disclosure • Board structure & operations 9

10. 1. Strategy and Planning • Board contribution to strategy is lacking • Area most in need of improvement • One director says -- 10

11. “If the board isn’t comfortable with the strategy . . . it should tell management to rethink it, and come back with something better. But, the board shouldn’t be involved in developing the strategy. That is, noses in, fingers out.” U.S. director 11

12. Management Intractably committed to one course Impatient with directors not sharing commitment to chosen path Holding on to bad strategy too long Highly controlled strategy- discussion agenda Directors Hesitant to aggressively, constructively challenge Insufficiently prepared Fearing isolation, replacement Insufficient time, resources 1. Strategy Pitfalls 12

13. 1. Strategy and Planning Critical Elements for Effectiveness: • Enough time, atmosphere for full, frank strategy discussions • Aggressive but constructive debates, bringing directors’ skills, knowledge, insight • The right information on risks, interdependencies, resources, competitors • Application of lessons learned from past successful, unsuccessful strategies 13

14. 1. Strategy and Planning Critical Elements for Effectiveness: • Management uses robust process to develop strategy, with full buy-in • Comfortable with planned extent of change: incremental, substantial or transformational • Satisfied tactical plans will result in successful implementation • Consensus with management on performance measures for judging strategy 14

15. “There’s nothing like a big screw up to make a board get into the bowels of the real problem.” U.S. director

16. 2. Risk Management Another top issue on the board agenda:Directors witness examples of unmanaged, unknown risk bringing other companies to their knees, and they want to avoid unpleasant surprises at their companies 16

17. 2. Risk Management Pitfalls • No common terminology -- talking at cross purposes • Shortcutting the process, looking first at risk instead of strategic objectives • Responsibility at too low organizational level • Failing to eliminate programs not aligned with objectives • Taking “snapshot” instead of ongoing program 17

18. 2. Risk Management Critical Elements for Effectiveness: • Management has effective, robust process to identify, assess, manage risk • Align risk management actions with company’s strategy, business objectives • Understands significant risks, and comfortable with how management addresses them • Culture that assigns responsibility for and rewards appropriate risk management 18

19. “Corporations are getting away from their core activities and competencies into areas which have far higher risk, without properly understanding those risks.”Australian director 19

20. 3. Tone at the Top Critical Elements for Effectiveness: • Management practices desired values-based culture • Robust code of conduct in place and adhered to, with effective communication channels • Contact employees, customers, suppliers to independently assess de facto culture • Focus on ethical issues in mergers and other major transactions -- including partner companies • Directors’ ethics demonstrate desired values to management, employees, the world 20

21. “I’ve met some CEOs who had no respect for ethical principles. They got ahead over the strewn bodies of associates.” U.S. director

22. 4. Measuring and Monitoring Performance A major issue boards grapple with today: • Few companies measure and track the right elements. Many companies don’t understand what drives their shareholder value. • Directors are reluctant to raise concerns about potential impending trouble, because conclusive evidence is often lacking. 22

23. Performance Measurement Linkages IncentiveCompensation Strategies &Tactics Value Drivers Shareholder Value RiskManagement PerformanceMeasures 23

24. 4. Measuring and Monitoring Performance Critical Elements for Effectiveness: • Measures link to strategy, tactics, value drivers • Measures balance: • financial with non-financial • forward looking with retrospective • benchmarking against competitors, peers and best practice • key scorecard categories: operations, customers, employees, etc. • Targets set are tough, but not disincentives 24

25. 4. Measuring and Monitoring Performance Critical Elements for Effectiveness: • Comfortable information systems provide reliable, timely information • Measures link to rewards throughout the company, so all are pulling toward common goals • Rigorous follow up, identifying reasons for missed targets -- both under performing and greatly over performing 25

26. “Although boards hate bad news . . . executives need to get bad news on the table, and get it on the table early.”Australian director

27. 5. Transformational Transactions Critical Elements for Effectiveness: • Complete comfort with business reasons for proposed transaction, including how it links to current strategy • Critical evaluation of management’s information, transaction assumptions, ability to integrate target successfully • Application of lessons learned from past successful and unsuccessful transactions • Courage to walk away from a bad deal 27

28. 5. Transformational Transactions Critical Elements for Effectiveness: • Obtaining counsel of objective advisors • Recognize change in allegiance and differing objectives of management in to-be-divested units • Ensure company has right partners, reliable due diligence and properly structured deal before entering joint venture or alliance • Critical review of proposed capital expenditures, ensuring link to strategy 28

29. 6. Management Evaluation, Compensation and Succession • Tends to be a sticky issue for directors, given natural discomfort with judging peersBoards increasingly proactive in replacing executives who are not working out -- but problems might have been avoided 29

30. “High executive turnover does not bode well. It indicates a CEO that is fickle, intolerant or difficult to work for.”U.S. director

31. 6. Management Evaluation, Compensation and Succession Critical Elements for Effectiveness: • Agree upon performance criteria, targets, link to desired behavior • Continually monitor performance, providing clear, constructive feedback to the CEO • Ensure compensation helps retain the best talent, while paying for desired performance • Courage to replace CEO if necessary • Evaluate, develop relationships with key executives • Comfortable with succession plans 31

32. 7. External Communications • Financial reporting reliability in spotlight, with close regulator attention to incidents of improper financial reportingMarket focus increasingly quarterly, short-term. Also witnessing markets moving on non-financial information • SEC focus on fair disclosure -- Reg FD 32

33. 7. External Communications Critical Elements for Effectiveness: • Ensure skilled directors evaluate financial reports • Understand operating information disclosed by company, and how reliability is assured • Satisfaction management has effective communications policies and processes • Comfortable market-sensitive information properly handled to protect current, future shareholders 33

34. 7. External Communications • For leading audit committee practices, see the companion report:Improving Audit Committee Performance - What Works Best, 2nd edition 34

35. 8. Board Dynamics • Most corporate governance recommendations focus on matters of board form, as surrogates for improved board performance: • independence • board size • committee structure • number of meetings • While useful, these don’t ensure effectiveness 35

36. “I would rather see a smaller board wrestle with all the problems than a larger board delegate everything out.”American director

37. “Once you get beyond 10 or 12 at a board table, you don’t discuss -- you wait for your turn to speak.”British director

38. Bad Board is a necessary evil Good meeting: short meeting Rigid agenda, regimented meetings Impatience with directors Directors beholden to CEO All information from manage-ment, little analysis, no options Good CEO believes he/she can learn from board Real discussion in meetings Relationships outside boardroom Atmosphere of openness, trust Process, not event -- continuous responsibility Assertive, constructive engagement 8. Board Dynamics 38

39. “Directors need to see their role as a process, not an event. Their role goes beyond attending meetings.”American thought leader

40. 8. Board Dynamics • Thought leaders agreeDirectors need to spend more time fulfilling their duties, and need to be paid more 40

41. ContactInformation Richard M. Steinberg PricewaterhouseCoopers, Leader, Corporate Governance e-mail: richard.m.steinberg@us.pwcglobal.com phone: (973) 236-7280 41

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