The case for governance best practice codes in a US context

Over a dozen Stewardship Codes are now established - or in the process - around the world. Should there be a stewardship code in the USA? What are the benefits of having a code – and disadvantages? What can be learned from those in jurisdictions where a code already exists? 

  • Peggy Foran: Chief Governance Officer, VP and Corporate Secretary, Prudential Financial, Inc
  • Guy Jubb: Global Head of Governance and Stewardship, Standard Life Investments
  • Ric Marshall: Executive Director ESG Research, MSCI
  • Anne Sheehan: Director of Corporate Governance, CalSTRS
  • Chaired by Dr. Stephen Davis: Associate Director and Senior Fellow, Harvard Law School Program on Corporate Governance 

Dr Stephen Davis, Associate Director and Senior Fellow, Harvard Law School Program on Corporate Governance:

I would make this case, that in 2015 we have seen the rise of engagement between boards and shareholders to a degree in the United States that we’ve really not seen before.  And so, you have this fact on the ground of Corporate Directors, engaging with real owners, institutional investors and talking about how to frame the practices of corporate governance within a specific company.  It’s something remarkable and I’m sure we can expect this’ll be carrying on in the future. 

But when we think about market practices and not single company practices, we are still in a different age.  We’re in an age when the default of what the rules are and the frameworks are for the market as a whole, is law, or is regulation, and both of those are blunt instruments.  Sometimes, because of the state of regulation, it can be dysfunctional, random and arbitrary, and very often, law and regulation is not really attuned to the way either business works, or the way the investment world works.  And if it isn’t law and regulation that we default to, it’s the Proxy Advisors, who are our default standard setters.  And I’m not disparaging them, it’s just a way of life that we don’t have a way in which players in the marketplace, actors with skin in the game, can come together, as they do now on a company by company level, but at a market wide level, to figure out what are the practices of corporate governance that makes sense.

Now, the United States is, in some respects, unique in not having a channel for discussion.  Since the Cadbury Report was issued in 1992, there have been about 90 markets that have developed comply or explain corporate governance codes.  Which essentially represent agreements among major market parties, about what are the best practices.  It’s not law, and it’s not regulation, and it can be changed as market conditions change. It’s comply or explain, rather than penalise, if you don’t meet the letter of the regulation.  In addition to those corporate governance standards, we now have stewardship codes, which began in the UK, but now are in nine markets.  The latest one being Japan, and that’s as of just quite recently.  So, those kinds of soft standards, have developed now worldwide and the question before us today is, is the time ripe for us to consider a corporate governance code, and maybe also a stewardship code, maybe together, in the United States? What benefits are there, or what are the experiences of having those, as opposed to not having them?

Guy Jubb, Global Head of Governance and Stewardship, Standard Life Investments:

In terms of the benefits of codes in the UK we have two primary codes.  The UK Corporate Governance Code and the UK Stewardship Code, and the benefit that comes from a code based approach, an approach based on principles, on a comply or explain basis, is that it enables flexibility, but flexibility with accountability.  If you have flexibility without accountability, you’re on a road to nowhere and you need the two to come together, to enable the checks and the balances, and at the end of the day, corporate governance is all about checks and balances.  You need the two codes to come together to enable boards to operate, but operate in the best interests of the shareholders, and for investors to hold boards to account, but to do so in a way that is transparent, insofar as that they are required under the stewardship code to explain how they have applied the seven principles that are put to them, to do so in a way that is in the best interests of their clients, or their beneficiaries, if they are asset owners.  So flexibility is very, very important.

Stephen referred to codes as being soft standards, but I would suggest that codes of themselves are not soft standards.  They require thoughtful approach by both companies, by boards and by investors as to how they are applied, and to make codes really work, you need to have a little bit of regulatory underpin to enable that to happen.  So, in the UK, when Sir Adrian Cadbury produced his report, he suggested  that the London Stock Exchange should actually require companies to adopt that code and the Stock Exchange required that, so  it became a requirement for listing, that all companies had to comply with the substance of the code and provide a comply or explain approach.

First, I think that one can adopt, and it’s too easy to adopt, a culture of compliance.  Companies in particular will tend to find it easier to comply with the provisions of a code, and therefore avoid a difficult AGM, even when they would feel in their hearts it would be better to do something that was not in compliance with the code, and provide an explanation, but doing that invokes, the wrath of Proxy Advisors and, consequently, shareholders and boards just feel it’s not worth the candle.

The second issue about codes, is that over time they can grow like topsy.  The Cadbury Code was well under ten pages when it was first published.  You could get your head around it and boards could apply the principles thoughtfully.  Now, the UK Governance Code is running to over 30 pages, and there is a point where, perhaps, a code of principles, somewhere along the lines, becomes a code of rules.  I’m not suggesting we’re necessarily there at the moment in the UK, but it is a danger that one has to be mindful of, if one is going down the code route.

And finally, in terms of the shortcomings of codes, we have found ourselves, and since the financial crisis, experiencing, both in the UK, but elsewhere as portfolios of global investors become more diversified geographically, there has been a dilution of domestic stewardship.  This means that in terms of the conversations that take place between boards and their shareholders, the engagement that takes place, it becomes more difficult sometimes for boards to get shareholders who are willing, because they are spread around the world to engage in the quality of dialogue that is intended, and equally, the views of the shareholders actually becomes more diverse, rather than otherwise, and that can actually make it quite difficult for companies to take decisions.

So, globalisation, in terms of the field of codes, is an emerging issue, which could dilute the effectiveness of codes. 

Peggy Foran, Chief Governance Officer, VP and Corporate Secretary, Prudential Financial, Inc:

I think it’s unlikely, unless something else happens, there’s a scandal, unless there’s a strategy involved in this.  We have a 50 state model, with a federal overlay and the federal overlay. That has been our model, and it’s been a particularly good model. 

There are notable best practices out there from a number of organisations.  There’s a Business Roundtable Best Practice that I know was updated mid-2000 and it may have been updated again.  There’s Aspen principles, there’s NACD, so there’s notable practices out there that people look at and they follow, CII, as best practices.

I remember when I was Advisor, I put our top 30 shareholders in the room with the board, and there was controversy surrounding that because it was the first meeting really to have investors talk to board members.  But one of the things that was very interesting to the board, is really they see the diversity in the room, that not all investors thought alike, and to really, for a principle, in order to get people to agree to various principles would be very hard. 

Now, there are certain things that companies could agree to.  There’s probably 20 high levels, but in any event, I think part of getting something like this out, is to have the dialogue and to have the agreement, and to come to the conclusion of what the best practices are.  Recognising that there will be instances where, if you’re not necessarily four scores on that, that you will disclose it.  I do see benefits, but given our system and the overlay, I see a tremendous amount of redundancy.

Stephen Davis:

Peggy is saying we’ve come some way along that road of creating a code, but we don’t recognise it as such, because actually, we have got lots of different initiatives.  No single authoritative code as might exist in another market.  So we have different people applying different standards, but not a single one.  I think your argument would be that if it would happen in the United States, the trigger might be a scandal.

Peggy Foran:

Well, that’s what I’ve been on a couple of the taskforces that have looked at this and my advice to investors that really would like a code, is to draft one right now, put it in your drawer, the next time there is a major scandal and people are going all over the place with Dodd Frank and Sarbanes-Oxley and legislation, take it out.  Because I think the business community would be very willing to have something like that, instead of the type of legislation that they’re used to.  So  I think it’s a compromise. 

But the interesting thing now, if you look at a lot of the better proxy statements, you see companies trying to put charts that say, this is what we do, this is what we don’t do, and interestingly, it seems like these are the basic things you as investors, we think this is what you would want and we do them.  There are some things that you would not like and we don’t do them.  So, I think in many ways, companies would like something a little more definitive, as you would see with a code, but I think, there’s too many people that have skin in this game, because of the state and the federal.

Stephen Davis:

Okay, so that sounds like a bit of an invitation to, you said the investor community, but maybe a broader group to get something ready for when a scandal might erupt.  But let me ask Anne, if we were to think about an authoritative code, what would it look like?

Anne Sheehan, Director of Corporate Governance, CalSTRS :

I think it would probably reflect best practices, that have emerged and that where there is some consensus around.  It could have some aspirational aspects to it also, so that everyone may not be there yet, but it would be a nice place to get, if we could, and they could do it on their own path and in their own way. 

I think one thing that was interesting that Peggy said, that actually matched with the answer to the question about the market developing something and investors, or the other players, putting it in the drawer, because I think the answer to the first question was, some sort of market solution.  I’m a big believer in us taking control of our own destiny, I’m not trying to leave it up to the SEC, or some of the others.  It’s not their role in this country.  We don’t see the regulators and it has been said, we have such a large market, with 50 states, there are so many companies, so many investors as well as dispersed ownership.  So trying to corral all those cats, and herding cats is not an easy process, so that’s why I say, I think some of code, or guidelines and best practices.  I think amongst investors, and I don’t want to speak for all investors obviously, but there are some best practices and some voting patterns that you can see that have emerged over the years that people are accepting.  I think majority vote is much more accepted this day and age.  I think a lot of investors have concerns about certain aspects of poison pills.

I think the jury is still out on proxy access, but I think this past year, and these next couple of years, we’ll see where that becomes an accepted standard.  There are some that many investors could agree on.  I think the issue is, you’ve got the Corporate Governance Code, this is what investors like and this is what we expect of our companies.  I think the stewardship code is a little different aspect, and that is, what are the expectations that people have for investors, in terms of how we carry on our business as investors?  How do we engage with companies?  How do we put out what our guidelines are?  All of those types of issues.  They could be in one document, but I think they have perhaps different audiences, depending on who you’re talking to.

Peggy Foran:

This takes a long time.  Aspen had an initiative, it was eight years ago, and it took a long time with investors, public pension funds in some companies, and interestingly, they could not get full agreement.

Stephen Davis:

I wonder whether given the evolution of the market, since that period, and certainly in the last year or so, where you have investors playing a very different role than they used to play and companies doing engagement in a way that they didn’t do before, even at the board level.  That I just wonder whether that’s an opening, because otherwise, the default again, for a standard setting is law or is the Proxy Advisor.  So, I’m just wondering, is there – might there be more of an appetite for that now?

Peggy Foran:

There might, but I think you have to get the right people to the table.  You know, who would represent whom, type of thing.  Do you get the NACD, do you get the BRT, do you get Aspen, do you get the society? But my sense is that would give you an outline that could be used and put in the top drawer.  And at some point might be very useful.

Anne Sheehan:

I think I would agree that things have changed and since the financial crisis, and there have been some evolution within the corporate governance world.  I think the SDX, the Shareholder Director Exchange, is a model that investors, companies and other Advisors came together to develop something.  So, we have moved, perhaps not as far as they have in other jurisdictions.

But I think one of the issues, is no one wants to, give their proxy to someone else when it comes right down to it.  But I think one of the benefits of even having the discussion, or trying, is going through the process to see where the agreement is, on some of these issues.  It may be that there’s agreement on 80%, but on the 20% perhaps not.  That process alone can be beneficial to the discussion, and if nothing else, it helps us see how the other side is seeing these things and from our perspective, we always learn when we sit down with companies.  We have our view going into the engagement, and we come away being educated on how they see it through their eyes.  So I think that process alone is very good and beneficial to the players, if they’re willing to sit down.  I also think the old adage that ‘perfect is the enemy of good’, would come into play in this type of discussion, because you would have people who feel very strongly about certain issues, and they insist it has to be in that.  People have to come in with an open mind about what could be done as a starting point.

Stephen Davis:

Ric, why do you think the United States is so unique, in a sense that it has not, at this point, developed a national code?  What are the reasons that we could look to for explaining that?

Ric Marshall, Executive Director ESG Research, MSCI:

I’d like to take this back in time about 25 years ago, when I first started looking at these questions for myself.  Certainly a gathering of this type and this particular group of people, would not have occurred at that time.  We wouldn’t be looking at this discussion at all.  The opportunities that have been opened up, by virtue of the increasing engagement and so on, that makes this discussion even possible in this country, is relatively new.  So I think it might be worth looking at how we got here.  When I go back 25 years, if you had asked me, what is the single most salient feature of US corporate governance?  I probably would have said at the time, that it was the extraordinary degree of power, welded by the CEOs of widely held companies.

We have been looking at the distinction between widely held companies and controlled companies.  The sort of power that, in the rest of the world, only occurs when there is a controlling shareholder, and the controlling shareholder is represented by the CEO, often is the CEO.  But in this country, we saw the rise of that at the management level and embodied by the CEO, and as a consequence of that, we ended up with certain kinds of governance problems that were relatively unique to this country.  Such as the extraordinary levels of CEO pay that occurred over the course of the late 80s, 90s and earlier in this last decade and I think it’s worth reflecting on what lay beneath that. 

Probably, most importantly, the fact that the US economy was doing so well, was dominating the world for so long, that US CEO’s perhaps felt they were on top of the world.  We had a prevailing economic and legal theory that said that the bottom line was everything.  We weren’t looking at lifetime employment, we weren’t looking at social impacts, environmental impacts; we weren’t looking at anything but the bottom line.  The CEO had a very clear job and the board had a very clear job, and that was to maximise profits.  It’s the extraordinary patchwork quilt of case law that we have, which is really what currently dominates corporate behaviour in this country.  We have this obsession with litigation, as a means of resolving a lot of these conflicts and problems, and so as a result, we’ve ended up with this system that’s very complex, with a lot of obstacles and I think they have their roots, and this historical pattern of development.

If you look at the corporate governance characteristics of any market, you can really only understand it by going back and looking at the history of how the particular practice is developed in that market.  You cannot understand the Japanese corporate governance system, without understanding how Japanese boards evolved over the last 40 or 50 years.  And I think the same thing is true here in the United States.  We are dealing with these legacy issues, and they need to come out, they need to be talked about and they need to be dealt with.

Guy Jubb:

I think focus on change is actually where we should be on this, and it’s the dynamics of change.  When I was here ten years ago talking about corporate engagement, and in the UK we’ve done corporate engagement, really since the Cadbury Code came into being.  It’s evolved.  But the question was, ten years ago, why should we engage?  Now, the question is, how should we engage?  Not only how we should engage, but how we should engage better.  We have found, in the United Kingdom, that the codes that we use, they’re living codes, they’re not ones which are stuck in stone, they’re ones which are reviewed every two years by the Financial Reporting Council, who is the owner of the codes.  They’re reviewed in consultation with companies, with Boards of Directors, with investors and others and other stakeholders.  Every two years a number of changes are made to improve the codes, to make them better.  This does give rise to the growth in the size of the code, so there is some downside to it.  But these are living codes and the codes, if they were to be adopted in the United States, I would strongly encourage them to have that degree of refreshment built into them from day one.

Peggy Foran:

I could see a group of us getting together right now and figuring out the ten top best practices.  I think you could probably find an agreement on that.  But when you start getting into that middle ground, it’s going to be harder.

Stephen Davis:

The approach that I’m hearing is a at some stage group of corporates, and a group of investors, and others, would come together with some common ground, asking where are the current cracks that intersect, but really not expecting that to take hold until the next crisis, or panic.  Now that’s very, very different from other markets, where codes, or best practices, have really been, in part, driven by Governments.  In fact, even as I mentioned the latest one, Japan that was really driven by the Abe Government.  Not authored by it, but driven by it.  Is there any prospect of any Government entity driving a code in the United States? 

Ric Marshall:

One thing that we certainly agreed on, is that the standing rule for counsel and at corporations, for many years, was that Directors shouldn’t speak with shareholders, because there was liability attached to that, and that’s part of that litigation history.  Well, that’s broken down. Sometimes it takes that enforcement, and we saw that with say on pay.  There was engagement and the discussion was expanding, and that helped to break it open.  It would be good to have a sponsoring body that could bring these groups together.

Stephen Davis:

Are there US bodies, the CII, the NACD, are there some established bodies that we could look to as potential drivers of this?

Anne Sheehan:

There are certainly bodies that you could look to.  Whether they want to take the lead on doing something like this is a different issue, but there are established bodies who represent many of the interests that would be addressed in such a code.

Anne Sheehan:

The SDX was a grassroots effort of a number of companies, investors, advisors, law firms and others, who felt it was beneficial to come together and put out some standards and some principles about engagement.  I think there is a model for that can work organically, and you have to recognise and acknowledge the culture in this country, we’re not going to do it out of the Government, and I’m not sure we should.  I’m not sure that’s the role of the Securities and Exchange Commission (SEC).  We have to figure out what the role to play is for the Government; the SEC is already overburdened with a list of things that they’re going to do, and adding this to that list, I’m not sure would really benefit investors in the long run. 

So who else could step into the breach and step up and do this?  And it could be investors with corporations, and some of the Advisors coming up and using the SDX as a model.  The investors were a little ahead of the proxy advisory firms, in terms of who sets the standards, which was heartening to see.  Because I do think the proxy advisory firms, while they have become the de facto standard centres, they do reflect much of what the investor clients tell them, in terms of what we’re looking for in our voting practices.  Sometimes it’s easier for some companies to yell at the advisory firms, than to call me up, or some of the other investors and yell directly at us.  So, I think the investors have to own how they have played into de facto setting the standards, and letting people know what their voting practices and policies are.

Peggy Foran:

It’s important, from a corporate perspective, to recognise this is not just governance standards, but we’re talking about a stewardship code, that with power, comes obligation, so I think that would make it easier.  But I also think, you really have to go to those courageous leaders out there that you think would get followship.  People who can really command groups, who have courage and are open minded. We would need to clearly articulate what are the benefits for doing this; what’s the problem you’re trying to solve and how this will help that problem.

Richard Bennett, President and CEO, ValueEdge Advisors:

I have a couple of thoughts, one is, what is the point?  What problem are we trying to solve?  The notion of putting something in a top drawer so that after the next panic  it’s absolutely horrifying that we would find something we’ve been trying to create that would solve a problem after it’s occurred.  Isn’t that a total dereliction of duty, for us as leaders of the capital markets?  If we’re going to do this, with the point is to clean up after the next crisis, maybe the point should be what can we get to that will happen to flag the possibility that that crisis will occur? 

I think that Government is not the solution.  As responsible leaders in the capital market, we really ought to decide what the problem is that such a code would solve and then set about solving it.  I think the notion of a prophylactic against the next crisis, is exactly the right goal to have in mind as we group these people together and get them to do something important.

Marianne Harper Gow, Director, Corporate Governance , Baillie Gifford :

As a foreigner, I think the thing that would make the most difference quickly, would be access to the board, and being able to engage with the board.

Mauro Cunha, Chief Executive Officer, AMEC:

My comment is, there may be a role for Government and we’re feeling that in Brazil as we try to turn the Corporate Governance Codes, into a comply or explain mechanism.  You get investors on one side and companies on the other side, they don’t agree and, forgive me, ‘cause it could be an oxymoron, but you could have the Government get in as an honest broker to settle this, and really try to set these standards.  My question is, given the experience in the UK, how do you ensure that the entity, only in the code, will not be captured?  We have a lot of experience with self-regulation and a number of times they become irrelevant because of capture.  How do we avoid that?

Manuel Isaza, Associate Director - Governance & Sustainable Investment, BMO Global Asset Management EMEA:

There were a number of references made to history and how that has played a role, and then the point about waiting for the next crisis.  In the US particularly, that history has shown that after a crisis the solution has come from the regulator.  It probably hasn’t been the most ideal solution in many cases.  A point was made that for these codes to work, there needs to be a little bit of a regulatory underpin, where could that regulatory underpin be in the US?

Paul Lee, Head of Corporate Governance , Aberdeen Asset Management:

I think if we believe that Corporate Governance Codes prevent crisis, the UK is actually a marvellous example that shows that that’s not true.  The UK had just as much of a financial crisis as the US did and its banks behaved exactly the same way US banks did, and it made no difference that there was a separate Chairman and CEO, and it made no difference that there was a Corporate Governance Code, so, I don’t think those things are linked, and that’s not a good reason to have the code.

If we go down the road of trying to put a voluntary code together and I suspect that’s the only way it can work in the US, there will need to be a sponsoring body.  We haven’t heard much about the Stock Exchanges. In some countries in Europe, it is the Stock Exchange that sponsors the Corporate Governance Code. That is a possible opportunity, but there does need to be a sponsor, and the sponsor is going to have to be a space where people can come together and have the conversation, and it is going to take resources, both money and people to make it happen.

Peter Webster, CEO, Eiris:

Clearly something that’s on the move – previously we were dismissing out of hand the possibility of there being a stewardship code in the US so the ground is shifting in this area.  Today it sounds as though you solved the problem, actually.  Peggy has ten things you think could be agreed now, Guy has pointed out that if the code could be refreshed every couple of years you could go with Anne’s idea of not making perfect the enemy of the good it is, so that you start with what you can agree now and in two years’ time you add the things that turned out to be more difficult.  So it sounds like you’ve almost fixed it. So my question is just what is next?

Anne Sheehan:

You have the workings of something.  There’s agreement on a large number of best practices and what we see are governance standards, and I think many companies would also agree to those.  I also think, from the stewardship side, many investors have their processes in place as to what their guidelines are, how they engage when they escalate.  I think one of the issues, in this country, is when do investors work as a group and collaborate?  Some are less comfortable with that in this market.  Transparency about our processes some of us.  So there are elements that are out there that are reflected in what codes and exist in other.  But I think having one Government entity in the Stock Exchange with their job is to list as many companies as possible and so, while ideally and historically, perhaps the exchanges would have been a good place and they still have some best practices.  I sit on the NASDAQ Listing Council and in terms of what their role is, to get as many listings as possible.  Yes, they do set standards.  Yes, there could be a place that brings it together, but you’d have to just know what you’re getting into in terms of that and there are many companies are staying private.  So there’s all sorts of issues there.

But I do think that we have come further than we were, in this country, in terms of these things, and the issue is tying the pieces together.  We don’t want to have to wait for the crisis. There is going to be a crisis at some point and I think some of this at least gets the discussion in front of us as to what our expectations are as players in the capital markets, or what we hope the best practices are as players in the capital markets, knowing that as long as human nature is involved, you’re going to have issues that are going to come up.

Ric Marshall:

A good focus is, what’s the point?  I spend a fair amount of time with a completely different group of stakeholders, which is the Director and Officer Liability Insurance Underwriters, and the Directors that they serve.  This is a very risk averse, and they’re very concerned about the role of the Director and the fiduciary responsibility of the Director, and the liability of the Directors.  And I think the group that we’ve not talked about enough here today, is the Directors. 

We get questions all the time about how we rate a company and how we interpret something that appears in a US proxy, and the implied question is, what should we do?  What should the standard be?  And I think more than any other group, it’s not corporate management, it’s the Corporate Boards, it’s the actual Directors, particularly as we begin to expand the skill pool and diversify our boards.  These individuals are really looking for this kind of clarity and a code would benefit Directors more than any other group, including investors, in my view.

Guy Jubb:

The code did not prevent the financial crisis.  But what the crisis did do, it provoked a significant degree of reflection, reflection by boards, reflection by investors.  Much of that reflection was embodied in a report by Sir David Walker, who did a very detailed, but very thoughtful investigation into the governance of banks and other financial institutions.  But he didn’t stop there.  It was that report which actually gave rise to the recommendation that there should be a stewardship code for investors.  It was a recognition that investors needed to raise their game, and in the business of governance and stewardship, crises will arise but they do generate some improvements, hopefully for the future, but there is no guarantee around any of this.  On the issue of regulatory capture, thus far in the United Kingdom, the Financial Reporting Council is accountable to the Government, to the Department of Business and Innovation and Science, but it has its own Board of Directors who prepare their own report, develop their own strategy.  The Government has a right of veto over who is the Chairman of the FRC and in certain situations, one could envisage capture could occur, but there one could also envisage that the UK might be a much less attractive place for companies to list and raise capital.

Peggy Foran:

I think we can all agree here on ten things.  We probably can agree on five to seven bad things. So let’s define the trades’ bad apples.  I think we probably could get buy-in by a number of groups, at least to start a process, that we have something and then can see where it might go from there. 

Stephen Davis:

I think that we wound up, really coming to a view that in the United States, a code, if there is one, would not be something that emerges out of the public sector.  It would have to be out of the private sector and in fact, it may not be the creature of established institutions. It could be instead, the product of some courageous leaders, from the business and the investor community.  We are meant to be long-term investors, long-term capital players and so we need to think about and anticipate that there will be crises.


Download the transcript

The case for governance best practice codes in a US context.pdf