Corporate Governance Predictions in the Wake of the Global Economic Crisis

In the wake of the financial crisis, many financial corporations suddenly seemed to be built like a house of cards, not grand castles. Eyes turned, naturally, to the firms’ architects—their corporate boards and directors—and their role in contributing to rapid losses. The result: a fundamental shift in the corporate governance landscape.

The collapse of banks and financial service firms revealed that corporate governance lapses were a primary cause of failure. Many boards of directors did not understand their own business practices, failed to adequately monitor risk, and authorized incentive schemes that rewarded esoteric, high-risk transactions. Once news of these practices hit the media, the public received a quick education about the meaning and importance of corporate governance.

The broad array of governance problems can seem bewildering: inadequate risk management, lack of director independence, conflicts of interest, manipulative accounting policies, director incompetence and lack of minority shareholder rights. But new trends and corrections are starting to emerge, some of which might not have been possible before the crisis.

Dominant theoretical assumptions about free market efficiency and deregulation were often the basis for opposition to governance reform—now the economic crisis has called them into question. Meanwhile, rescue programs and government ownership of corporations are challenging the narrow definition of “private enterprise” and raising new governance questions about companies where taxpayers are major shareholders.

A New Era?

Certain trends will shape governance in the post-crisis environment. For one, the pace of governance reform is accelerating. Reforms that were sidelined or bogged down in debate are moving rapidly toward adoption—either voluntarily or by regulation.

The power of corporate boards also continues to increase. The director’s “job” has been expanding for the past 20 years, largely through piecemeal governance reforms driven by shareholder pressure, activism, best practice standards, and regulation. The consensus is now clear: directors must accept primary responsibility for corporate governance and performance. 

But as could be inferred from newspaper headlines, executive and director remuneration remains the defining corporate governance issue. Shareholders understand that remuneration is a window into the boardroom, revealing directors’ independence and competence, their understanding of business and strategy, their ability to resolve conflicts of interest, their willingness to protect the rights of minority shareholders and their commitment to long-term value creation. In the post-crisis environment, directors will remain under intense pressure to explain and justify their compensation decisions. 

Issues once seen as outside of the range of governance standards, including environmental practices, social impact, human rights, product safety and community outreach, are now being prioritized. Boards and managers are expected to define these issues strategically in terms of business and reputation risk, cost, competitive position, and opportunities for growth. 

Given these trends, the global economic crisis signals a change of direction in the evolution of corporate governance. The new governance landscape, in which dialogue and engagement will displace traditional shareholder initiatives, will include many new defining characteristics.

For one, companies will increasingly recognize and accept the strategic and economic benefits of sound corporate governance. They will become less defensive and will increase efforts to engage constructively with shareholders.

Shareholders will submit fewer resolutions and will reduce their reliance on activism, turning instead to dialogue and less-public forms of engagement.  This change reflects several factors: the size and power of institutional investors; growing awareness of their own governance responsibilities; the success of past governance initiatives in securing shareholder rights; and the shift to strategic and substantive issues unsuited to shareholder proposals and confrontational tactics.

In turn, business culture and behavior will gradually change as directors seek a tone at the top that rewards diligence, teamwork, and long-term performance.  High-profile superstar CEOs will be less of a strategic asset than plan responsible leadership, and corporate boards will work to rationalize executive remuneration and link it to performance.

But let’s be real, the olds ways are not gone forever. Even in this new economic landscape, takeovers, contests for control, hedge fund activism and short-term performance pressures will continue to make life difficult for companies and shareholders alike. However at least the economic crisis may help to usher in a new era of greater responsibility.

John C. Wilcox is the Chairman of Sodali, a global consultancy, and will be speaking on the topic of corporate governance at the AS/COA Latin American Cities Conference in São Paulo, Brazil, to be held on June 9, 2009.