The knowledge that board members are expected to acquire and how they are expected to provide oversight in the wake of an expanding agenda of geopolitical, economic, environmental, regulatory, supply chain, and data and privacy risk issues and technology shifts is challenging the collective performance of boards. The idea of how boards need to effectively manage risk has expanded immensely and has become a key topic in board discussions.

Currently, there are three major gaps in skills and knowledge that boards need to address:

1. Risk issues — This idea of how boards need to effectively manage enterprise risk has become a key governance topic for boards. Many boards are challenged by members’ lack of experience in critical risk areas, which include geopolitical, supply chain, environmental, and financial market risks, says , Global Practice Leader of the board services practice at Major, Lindsey, & Africa. In particular, the external technology drivers of enterprise risk that companies cannot control, which include cyber, generative AI, and the disintermediation of business models that now may only be addressed during the board’s annual strategy review.

2. Human capital management concerns — Corporate directors need to focus more than ever on broad employee issues because of the number of factors stemming from the pandemic era, according to , Managing Director and Head of Investor Strategies at Just Capital. Allen-Ratzlaff also sits on the U.S. Securities and Exchange Commission’s Investor Advisory Committee, which recently recommended that the SEC . “Board members need to make sure they have line of sight into how well the workforce is managed, including key information to help assess management quality in this area, because investors are going to ask you about it,” Allen-Ratzlaff says. Meyer agrees, adding that historically, “boards have narrowly focused on compensation, but now the human capital agenda is much broader.”

3. Governance effectiveness —Typically, boards in the past have evaluated their own performance, and some boards are finding out that they do not have the level of acumen necessary to accurately gauge their own effectiveness. “Boards are waking up to the fact that they need to access outside resources to help think through, at the board-level, governance effectiveness,” Meyer explains.

Guidance for boards to address deficiencies

The necessary actions for boards to take go beyond acquiring new talent to address knowledge gaps must include addressing shortcomings and changing board practices around continuous learning and performance.

Here are some ways this can be done:

Adjust committee structure to expand the scope of oversight — Traditionally, there are three main board committees — the nominating and governance committee, a human resources and compensation committee, and an audit committee. Outside of financial services companies, most boards do not have a risk committee, says Meyer. The increasing scope of enterprise risk issues winds up in the audit committee, but collectively “there is a skill gap on many boards, including within the audit committee, around how to even consider potential geopolitical or external threats,” he states.

Alter succession planning to address near-term needs — Boards are moving from a very rigid succession-planning process to a more flexible one, and they are shifting the priority of who they want to bring into the boardroom next, according to Meyer. To keep up with the pace of the external environment, this process needs to move more quickly to better add new capabilities and experience into the boardroom.

Involve company management in board evaluation and knowledge seeking — A small number of boards formally ask the CEO, CFO, general counsel, and other senior leadership team members who are in close contact with the board to annually participate in the board self-evaluation process. However, boards need to not only engage senior management in the process, but also should solicit feedback from major investors and key regulators on a regular basis, Meyer explains.

Involving company leaders in the process will help the board target specific areas for future development and prioritize skill gaps that need to be addressed, while external stakeholders will provide new perspectives on market risks and external threats and opportunities that can help shape the future board agenda.

Evolve board culture — The next generation of board members are changing the governance culture and expecting individual performance to be part of boards’ annual evaluation processes. While progress on diversifying boards over the last five years has been significant, it needs to speed up. The next generation of board members have advanced in their career by successfully growing, learning, and developing through receiving feedback, and they are bringing this expectation into boardrooms. “The relevancy in the boardroom for corporate directors who are no longer working day-to-day running companies and functions is on a faster decline rate than ever before,” Meyer says.

To help offset the trend, there needs to be proactive, continuous learning experiences for board members. And while adding ongoing learning on top of other board issues will be a challenge, it is critically necessary to maintain adequate board performance and oversight across a broadening and ever-changing boardroom agenda.

However, leaving the G — corporate governance — out of the equation can be a recipe for disaster. And that is because governance is what helps ensure that environmental and social issues are managed effectively from the top down.

Simply put, governance covers the system of controls, procedures, and practices that a company adopts to govern itself. Good governance involves business ethics, transparent information disclosure, accountability, effective risk management, and proper financial reporting and regulatory compliance, all the while addressing stakeholder needs.

Getting the governance part of the equation right is extremely important, especially in the context of the from the U.S. Securities and Exchange Commission (SEC) that went into effect late last year. The pay vs. performance requirements add complexities to existing executive compensation reporting requirements that good governance can help navigate.

Implementing the G in ESG

In August 2022, the SEC issued its final rulemaking release on pay vs. performance, and the rules were intended to make it easier for investors to evaluate a registrant’s decision-making with respect to its executive compensation policies. The new rules require all registrants — except for emerging growth companies, foreign private issuers, and registered investment companies — to disclose in detail the relationship between executive compensation and company financial performance.

In the spirit of clarity, SEC Staff at the Division of Corporation Finance updated its in February 2023, responding to certain practical and implementation questions about the new pay vs. performance requirements.

Registrants must begin complying in proxy or information statements required to include such compensation information for fiscal years ending on or after December 16, 2022, meaning as early as this 2023 proxy season for calendar-year registrants.

The SEC wants registrants to align their pay vs. performance disclosures with the agency’s new rules, with an eye toward improving transparency and corporate accountability by providing investors with information that will help them assess registrants’ executive compensation practices when, for example, exercising their right to cast advisory say-on-pay votes.

Practical considerations & best practices

For registrants to provide meaningful disclosures in line with the pay-versus-performance rules that help guide investors’ decision-making process, it is important that corporate management and boards of directors put into place controls and procedures to help ensure that material financial and nonfinancial information required to be disclosed is identified and communicated in a timely manner.

Plan ahead and coordinate internal and external efforts — The pay-versus-performance disclosures require registrants to collect new information and make new calculations unlike those required in prior years for proxy statements. Thus, it would behoove registrants to coordinate with their boards, particularly their compensation and audit committees; with key in-house departments, such as finance and accounting, legal, public relations, and human resources; and with external advisers, such as compensation consultants and legal counsel, to help ensure that all newly required information is captured.

Consider the benefit of keeping new pay-versus-performance disclosures out of CD&A — Many registrants will likely find it worthwhile to keep the new pay vs. performance disclosures separate from those typically used in the Compensation Discussion & Analysis (CD&A) parts of many proxy statements. In the CD&A, especially during the first year, registrants may want to avoid suggesting that the tabular disclosures guided compensation decisions, unless the disclosures happen to align with the narrative in the CD&A.

Consider potential impact of new pay-versus-performance rule on say-on-pay — Given that the new pay vs. performance disclosure requirements are a component of executive compensation disclosure; and, thus, can affect investors’ say-on-pay advisory votes, registrants should consider reflecting on how these disclosures may influence advocacy for favorable say-on-pay results.

Consider proxy advisory firm response to new pay-versus-performance rule — The new pay vs. performance disclosure requirements may eventually lead proxy advisory firms — such as Institutional Shareholder Services, Glass, Lewis & Co., and others — to decide upon an acceptable correlation between company performance and executive compensation and apply it in their say-on-pay recommendations regarding registrants. Although it is unlikely that any meaningful assessment of the impact of the new disclosures on corporate governance ratings and voting policies issued by proxy advisory firms will occur until after most registrants with a December 31 fiscal year-end have filed their 2023 proxy statements, registrants may want to consider in advance how they would respond in light of their particular facts and circumstances.

Consider how new pay vs. performance rules may influence financial analyst assessments — When assessing financial performance measures to be included in the Tabular List and the Pay vs. Performance Table, registrants may want to consider the potential impact of the new pay vs. performance disclosures on financial analyst views, especially since disclosures in the Tabular List could affect the metrics used by analysts in evaluating and predicting a registrant’s financial performance. Further, discussions of the relationship between executive compensation actually paid and company performance measures may impact how analysts evaluate future company disclosures.

While ESG matters are increasingly dominating executive and board agendas, the G — for governance — too often does not receive equal attention, which can rob registrants of the opportunity to leverage the power that comes from embedding risk management systems and other elements of sound governance into their corporate structures.

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