Since the onset of Covid-19, corporate boards have faced a string of difficult decisions. Take the question of dividend payments: Ordinarily, the decision would be a relatively straightforward matter of applying a stated dividend policy, following past practice, or choosing an amount based on shareholder expectations and the company’s earnings for the period. But this year, with Covid-19 decimating the economy and looming uncertainty about the depth and duration of the crisis, the decision became a complex matter of weighing and balancing multiple factors — at least for companies flush enough to consider it at all.
Boardroom dividend discussions ranged over a series of considerations: the equity and symbolism of returning cash to shareholders at a time when employees were being laid off or furloughed; the potential future opportunities gained (or lost) by following (or going against) government calls for dividend cuts; the reputational and signaling effects of maintaining versus suspending or reducing the dividend; the expectations of shareholders and the proportion reliant on dividend income; the company’s cash position and strategic plans; and what would be prudent in the face of extreme uncertainty. A decision that would typically require only a few minutes of board discussion — if that — became an hour-long (or more) deliberation. And then there was the discussion about how to explain the decision in the company’s public communications.
In the end, some boards decided to maintain the dividend. Others decided to suspend or reduce it. In the U.K. and Europe, where policy makers and central banks urged cuts, the major banks and many companies followed their guidance. In the U.S., most of the large banks committed to maintaining their dividends, though authorities and experts disagreed about the wisdom of that choice. Whatever the final decision, however, the process of reaching it was far from straightforward.
This is just one example of the reality that boards are facing as a result of Covid-19. The new environment is characterized by an increasingly complex set of pressures and demands from various stakeholder groups, heightened expectations for societal engagement and corporate citizenship, and radical uncertainty about the future. These factors are complicating board decision-making and challenging the shareholder-centric model of governance that has guided boards and business leaders for the past several decades.
The shareholder-centric model, which is based on what academics call “agency theory,” appears to be giving way to a richer model of governance that puts the health and resilience of the company at its center. The pandemic has made all too clear that society depends on well-functioning companies to meet its most basic needs — for food, shelter, communication, you name it — and that companies do not exist solely to maximize returns to shareholders. It follows that boards, which by law are a company’s governing body, should be concerned not just with returns to shareholders, but with the full range of factors that enable the company to create value over time. Paradoxically, this enlarged purview does not diminish boards’ accountability to shareholders, but it does imply changes in the nature and scope of that accountability.
Whether Covid-19 is truly an inflection point for corporate governance is yet to be seen, but there is no doubt that the pandemic has challenged core premises of the agency-based model of governance in ways that have important implications for boards. In this article, I discuss several of these challenges and suggest five ways the board’s job is likely to change in the post-Covid era. As boards go through their annual self-assessment process, they will want to review their capabilities and readiness in each of these areas.
Read a list of questions and statements boards should consider including in their self-evaluation.
More Structured Attention to Stakeholders
Shareholder primacy is the cornerstone of the agency-based model of governance, but if the pandemic has shown anything, it is the importance of each and every stakeholder group to a company’s ability to function, let alone thrive and succeed over time. In the face of Covid-19, some companies struggled because their customers disappeared. Others saw their workforce reduced to a skeleton crew of essential employees. Still others grappled with supply chain disruptions, unsustainable debt, or insufficient capital to fund their operations. Since the onset of the crisis, it has become common practice for management to update the board on the situation regarding each stakeholder group, and many boards and senior leaders have declared the health and safety of employees and customers to be their top priority. Some investor groups as well have weighed in on behalf of putting employees first during this perilous time.
The crisis has validated the logic of interdependence behind the Business Roundtable’s 2019 statement on corporate purpose, in which 181 CEOs pledged a commitment to each of five stakeholder groups — customers, employees, suppliers, communities, and shareholders — and reversed its endorsement of shareholder primacy. Coming out of the crisis, boards and senior leaders will find it even harder to say that shareholders — or, for that matter, any stakeholder group — has standing “primacy” over all the others. The crisis has demonstrated that the “primacy” of one group or the other cannot be fixed once-and-for-all. In the life of a company, there are times when employee interests must come first, times when customer interests should take priority, times when public need is paramount, and times when the interests of shareholders should be the prime concern. As reactions to Covid-19 showed, much depends on the nature of the interests at issue and the circumstances of the company.
These lessons from Covid-19 imply a more active role for boards in monitoring companies’ relationships with their core stakeholders. That may mean asking management to continue the Covid-born practice of periodic reporting to the board on the status of each group or, more formally, to establish goals and a reporting process that will allow the board to track the company’s performance for its stakeholders more systematically over time. Boards will also want to take a more active role in ensuring that tradeoffs among the interests of its various stakeholders are handled in a way that is consistent with its obligations to these groups and with the long-term health of the company. For that, it will be important for directors to have a shared understanding of the company’s purpose and strategy, as well as a framework defining the company’s stakeholders and responsibilities to each.
Many companies say they have commitments to all of their stakeholders, and that may well be true. But few boards have a structured process for overseeing those commitments or for tracking the company’s performance for its non-shareholder stakeholders. If they do, it is not something that is regularly reviewed and discussed in the boardroom in the way that performance for shareholders is regularly reviewed and discussed. To the extent that stakeholder concerns come into strategy or M&A decisions, it tends to be somewhat ad hoc or by exception rather than a routine part of the analyses that boards receive.
In the wake of Covid-19, boards will likely face increased pressure to incorporate stakeholder perspectives and voices, especially those of employees, into their oversight and decision processes. They will also be challenged to show that the company is performing well for all its stakeholders. External pressure aside, boards that have learned from Covid-19 will want to do this for their own purposes.
The pandemic has brought home the tight connection between business and society, and underscored the threat posed by risks stemming from large-scale societal problems that proponents of the shareholder model have traditionally regarded as outside the purview of business. The pandemic has shown that, theory aside, companies cannot so easily disconnect themselves from society-at-large.
Covid-19 started as a public health crisis and quickly evolved into a financial and economic crisis of epic proportions. As the virus made its way across the globe, few, if any, companies were spared. Some saw demand for their offerings collapse overnight, while others faced a deluge of orders. Many had to invent new ways of working in a matter of days, if not hours. Stock prices plunged and then fell into a pattern of unprecedented volatility. In the face of uneven and, in some cases, ineffective responses by governments and with economic recovery dependent on stemming the public health crisis, many companies stepped up to fill the gap even as they struggled with their own problems. In the many meetings and updates during this period, directors found themselves reviewing management’s plans not only for steering the company through the crisis but also for helping combat the virus or aid in the relief effort.
Many companies rose to the occasion, retooling their production lines to make needed equipment, providing open access to otherwise proprietary information, offering their facilities or services to health authorities, or bringing their capabilities to bear on the crisis in other ways. Others acquitted themselves less well, and got caught in the public’s crosshairs for seeking to take advantage of government programs intended for those less fortunate. Many boards and senior leaders were forced to grapple with vexing questions of public responsibility at the same time that they were struggling with a crisis for which they were ill prepared.
For at least a decade, calls have been mounting for business to help address systemic concerns such as increasing income and wealth inequality, environmental degradation, climate change, racial and ethnic discrimination, declining public health and education, rising corruption, deteriorating public institutions, and, yes, increasing risk of pandemics. While some business leaders have heeded the call and found innovative ways to help address these problems, many others have looked the other way or defined the problems away as “social issues” or what economists calls “public goods” problems and therefore, by definition, outside the scope of their legitimate concern as business executives and fiduciaries for their shareholders.
Covid-19 has shown that these issues are not only legitimate areas of concern for business but also, and more importantly, sources of both risk and opportunity. Like market forces, societal forces can profoundly affect the business and competitive environment. Coming out of the crisis, boards will want to work with their company’s leaders to ensure that the company’s risk management and oversight systems encompass the risks arising from these large-scale societal problems. They will also want to ensure that the company’s strategic planning and resource allocation processes take these problems into account, so that the resulting activities, at a minimum, do not exacerbate these problems and, ideally, help to ameliorate them.
In the wake of Covid-19 boards can expect institutional investors, governments, and the general public to renew their calls for companies to pay more attention to societal problems and to take a more active role in helping address them. By the same token, boards themselves will increasingly be expected to oversee the business and society interface. Instead of being the exception, robust oversight over sustainability, corporate responsibility, societal engagement, corporate citizenship, ESG — whatever you want to call it — will become the rule.
More Comprehensive Approach to Compensation
The pandemic has laid bare glaring disparities in pay across society and within companies. It also has brought to the surface several problems with the shareholder model’s traditional pay-for-performance paradigm, most notably its indifference to issues of equity (in the sense of fairness, including across gender and race) and to externalities such as impacts on third parties and the environment. The pandemic has also tested the paradigm’s suitability for conditions of extreme uncertainty when the motivational theories behind it are difficult to implement.
In its classic formulation, the paradigm defines “performance” solely in terms of returns to shareholders and treats pay as a tool to motivate executives to act in ways that will maximize those returns. In practice, this has evolved into a system in which boards set targets for actions or outcomes that they think will lead to shareholder returns and offer executives the prospect of large rewards in the form of cash or stock if — but only if — they achieve the targets. According to the theory, the prospect of the reward motivates executives to work harder than they would otherwise to achieve the targets.
What should boards do, though, when a surprise downturn renders the targets irrelevant, which is what happened in the pandemic? When revenues collapsed in the wake of the lockdown, targets that boards had set just a few months earlier to determine eligibility for cash bonuses and stock awards became instantly unachievable. Given the large proportion of executive pay dependent either on meeting the pre-set performance targets, boards were confronted with the problem of retaining and motivating the executives whose talents were sorely needed to see the company through the crisis. At the same time, the obvious solution of adjusting targets downward seemed to make a mockery of the whole notion of pay for performance, especially considering that targets are never adjusted upwards when unexpectedly favorable conditions make them easy to achieve. And few directors relished the idea of protecting the pay of those at the top while those same managers were simultaneously laying off or furloughing large swaths of the workforce during a time of general hardship.
The dilemma was all the more acute because of the gross disparities in pay between executive and management employees and those on the front lines in positions deemed essential to society’s functioning during the crisis. These “essential” workers not only bore the brunt of potential exposure to Covid-19, but they also tended to be the least well paid and the most vulnerable to health and financial risk.
Boards and senior leaders navigated this thicket in various ways. Some executives took temporary pay cuts in an effort to show solidarity with employees. Some companies handed out special one-time bonuses to those on the front lines. Some boards have, indeed, adjusted targets and thresholds downward, repriced options, or given executives new shares or stock options. But it is clear that these measures, while responsive to the moment, do not solve the larger problems of compensation design revealed by the pandemic.
For years, textbook teaching has held that boards should design pay so as to align the interests of executives with those of shareholders and that high-powered incentives are necessary to motivate executives to do their jobs. These ideas have created a system that is now deeply entrenched in practice even as research has revealed its flaws and even as enlightened shareholders have themselves called for tying pay to a broader set of factors linked to the company’s strategy, environmental impact, or social performance. Before the pandemic some boards were heeding the call, adding new measures of performance or otherwise seeking to align pay not just with short-term shareholder returns but with the longer-term health of the company and the needs of society. A few had linked executive pay with reductions in carbon emissions or with diversity and inclusion measures. With Covid-19 and the reckoning over racial inequity fueling new and more urgent calls for economic justice, it is only a matter of time before boards will be asked to justify the compensation paid not only to their top executives but also to rank-and-file employees, and to do so not just to shareholders but also to the broader public.
As the social and economic context continue to evolve, compensation committees will want to broaden their mandate beyond executive pay to include oversight over compensation policies across the organization. They will also want to make sure that their compensation programs are aligned with the company’s strategy and societal commitments, perceived internally as fair and equitable, and well suited for what is likely to be continuing market uncertainty.
As noted earlier, Covid-19 has complicated board decision-making and made it less amenable to general rules and simple formulas. The injunction to “maximize shareholder value” just does not have much purchase when it comes to deciding how much to invest in personal protection equipment to safeguard employees’ health or whether to convert an auto manufacturing line to the production of ventilators for a nation in need. Indeed, the pandemic has called into question many pre-crisis decisions that were taken in the name of maximizing shareholder value but that left those companies strapped for cash, saddled with debt, or otherwise ill-equipped to cope with the damage wrought by Covid-19. In this new environment, boards are increasingly having to rely on qualitative judgments in forming opinions and reaching decisions.
To be sure, the decisions that boards are called on to make have always required some measure of qualitative judgment. Adages aside, the numbers frequently do not speak for themselves, and many issues that rise to the board are not amenable to resolution through financial analysis or other quantitative techniques. That’s why deliberation and debate have always been important in the boardroom and why the capacity to engage in such discussion is a critical skill for board members.
The pandemic, however, has amplified the importance of judgment and, correspondingly, increased the amount of time that boards are spending in deliberative discussions exploring different options and weighing competing considerations and perspectives. That’s, in part, because boards are having to deal with novel issues and matters for which they have no precedent or policy. Before the pandemic, for instance, few companies had policies and guidelines on virtual shareholder meetings, so when they emerged as a possibility, boards had to explore and assess the alternatives and implications quickly and carefully.
But the increased need for deliberative discussion is also a result of changes in the context that have upended pre-Covid business models. Fractured strategies, heightened uncertainty about the future, increased scrutiny from multiple audiences, and the need to perform well for all stakeholders — all of these factors are making it necessary for boards to consider a richer and more varied set of inputs and perspectives.
Consider the dividend decision discussed earlier: Instead of focusing just on the company’s cash position and shareholder expectations, boards had to consider the perspectives of employees, governments, and the public, and of differing groups of shareholders — and each group’s likely reactions to the various possible decisions. Boards also had to consider issues of fairness and the possible ramifications of taking action that might be perceived as unfair to the public or to employees, especially if the company was expecting to benefit from government assistance programs. Boards also had to think about alternative scenarios for how the pandemic might evolve and what those scenarios implied for the company’s strategy and future cash needs. Through a process of deliberation, these differing factors and perspectives had to be weighed and prioritized; alternative courses of action examined; and, ultimately, a decision made as to what would be best, all things considered, for the company given its particular situation.
In this and many other areas, Covid-19 has raised the bar on deliberation and judgment in the boardroom, but the underlying factors driving this development will most certainly outlive the pandemic. Companies will continue to face a complex and uncertain environment in which they are nevertheless expected to meet multiple objectives and answer to a diverse group of audiences. As boards work with management to chart the company’s post-Covid strategy and allocate resources as between current and future needs of the business, they will need to spend more time considering the claims of different stakeholders and reviewing the potential impacts of their decisions under various possible future scenarios. They will also need more and better information to support these discussions.
This analysis suggests that a board’s ability to deliberate in a thorough and thoughtful, but efficient, manner and come to a considered conclusion will be a critical aspect of its effectiveness in the post-Covid era. As of today, directors and boards vary widely in their appetite and capacity for this sort of discussion. Board chairs, as well, differ in their ability to facilitate it. This is another area in which forward-thinking boards will want to assess themselves and, if needed, take steps to raise their game.
More Attention to Board Composition and Director Race and Ethnicity
The pandemic’s disparate effects and ensuing national outcry over racial inequity have put a spotlight on board composition, especially as it relates to directors’ race and ethnicity, a topic on which the agency-based model has been ambivalent at best. In his classic article on corporate social responsibility, economist Milton Friedman portrays the ideal “agent” (the theory’s term for a director or manager) as a generic male wholly devoted to maximizing the wealth of shareholders to the point of suppressing his own personal commitments — and even his responsibilities to family and community. In other words, the theory regards directors’ identities and personal characteristics as largely irrelevant for their roles.
This void in theory has been filled in practice by a custom of appointing directors with backgrounds as CEOs or CFOs, positions traditionally held by white men, and of drawing board candidates from existing directors’ own networks. The result has been a self-perpetuating system of boards populated mainly by white men of a certain seniority and background. Over the past decade, the gender disparity has been moderated somewhat by the push for more female directors. According to a study of Russell 3000 companies by Institutional Investor Services (ISS), the percentage of board seats filled by women went from 9% in 2009 to 19% in 2019. But racial and ethnic disparities persist and they are stark. Another ISS study found that only about 12.5% of directors at the nation’s 3,000 largest companies are members of racial or ethnic minorities, even though these groups make up 40% of the U.S. population. According to a 2019 study by Black Enterprise, nearly 38% of S&P 500 companies have no black directors on their boards.
A board’s role is to provide strategic guidance and oversight, and directors must bring the appropriate skills to address a company’s specific business needs and circumstances. The pandemic and the national awakening to racial inequities in all walks of life have made it abundantly clear that a diversity of experience and perspective in the boardroom is also crucial for boards to do their job. Monitoring the company’s relationships with its stakeholders, assessing strategy, overseeing risk, reviewing societal engagement, assessing pay practices, overseeing management’s diversity and inclusion efforts — these are just a few of the standard board tasks for which the insights of directors from different racial and ethnic groups would appear to be essential inputs. Studies have shown that the addition of female directors has altered board discussions and made them more robust. The addition of more directors from underrepresented groups is likely to have a similar effect.
Quite apart from the benefits to companies and from the moral case for affording individuals of all races and ethnicities the opportunity to be considered for board positions, the inclusion of directors from minority communities is also important for combatting the racial inequities that cut across society. Experts say that the pandemic’s disproportionate effects on African Americans and other underrepresented minorities are driven in no small part by social and economic disadvantages borne by these groups. These disadvantages are unlikely to be rectified until more leaders who understand these problems occupy positions of power and influence in business and the boardroom.
Pressure to take action continues to mount. Institutional investors are already calling on boards to disclose their plans for adding Black and other underrepresented directors to their ranks, and at least one shareholder lawsuit has been filed against directors alleging breach of fiduciary duty based on the board’s lack of racial diversity. California lawmakers recently passed a bill that would require the boards of publicly traded companies with headquarters in that state to appoint at least one director from an underrepresented community by 2021. Some companies have pledged to add Black or other underrepresented directors of their own accord.
Boards that have not done so will want to review their director skill matrices and their board succession plans with an eye to enhancing racial and ethnic diversity in a way that is consistent with the company’s strategy and the board’s need for other types of diversity — industry, geographic, domain expertise, gender, and the like. For many boards, it will be necessary to develop new channels for identifying talent, new approaches to onboarding directors, and more deliberate processes for building board cohesion in order to achieve their goals and realize the benefits of having a board whose membership is truly diverse.
Overall — A More Demanding Job
In summary, Covid-19 has made the director’s job more demanding. Since the onset of the pandemic, boards have been getting more frequent updates from management and having shorter, more frequent meetings to deal with a multitude of issues that have presented themselves. Surveys indicate that most directors are spending more time on the job. While the frequency and intensity of meetings is likely to decline somewhat as the crisis subsides, the new expectations of boards discussed above will inevitably require directors to devote more time to their role than has customarily been the case. Working more closely with management on strategy, tracking a richer set of performance measures, overseeing an expanded menu of risks, rethinking compensation policies, engaging in more thoughtful deliberation, reviewing board composition — all of these activities take time. And the ease of convening virtual meetings means that the new cadence is likely to include shorter, more frequent virtual meetings as well as periodic in-person meetings, once travel restrictions are lifted and safety can be assured.
As boards look to the post-Covid era they will want to assess their readiness to meet the new demands, and develop a plan to address any gaps they find. At this moment, when old assumptions are being questioned, they will also want to ensure that their members have a shared understanding of the board’s role and responsibilities, and of their individual role and responsibilities as directors. In the flurry of Covid-inspired activity, it is important that boards not lose sight of their central functions as governing bodies of the companies they serve.