iese insight

GOVERNANCE: RECOMMENDATIONS TO MEET FUTURE CHALLENGES TRANSPARENCY: A RISING TREND IN LISTED COMPANIESPROXY ADVISORS: ARE VOTING GUIDELINES RULING YOUR BUSINESS?RENEwING THE MISSION: 6 ITEMS FOR THE TOP OF EVERY BOARDS AGENDA

RELEVANTBUSINESS

KNOWLEDGE

deep insightMicrosoft reboot

From software to services constructive feedback

To give it well, you have to learn how to take itfast fashion

How does it work, and can it work for you, too?swiMMing against the tide

Olympic tips for performing at world-class levels

inside

second QUARTeR 2014 ISSUE 21 ieseinsight.com/review

Why Good

MattersGovernance

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INSIGHTS IDEAS RESULTSMOST AWARDED MEDIA AGENCY IN THE SPANISH EFFICIENCY AWARDS

GLOBAL MEDIA AGENCY OF THE YEAR 2013 - ADWEEKMOST AWARDED MEDIA AGENCY NETWORK 2013 - GUNN REPORT

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Discover what inspires the most awarded media agency network in the world and how more powerful insights, ideas and results can unlock greater success for your brand.

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Always thinkingAlways askingAlways doing

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ieseinsight 3 issue 21 second QuARTeR 2014

deep insightDossierinsight


Deepinsight

Boards need to close the rifts left by the crisis and be open to change, for the long-term success of business.Illustrations by RAUL ARIAS

15 How Boardroom History Is Writing Its FutureRecommendations to Meet Future Governance ChallengesBy Jay W. Lorsch

24 The Age of ActivismTransparency, a Rising Trend in Listed CompaniesBy Jos M. Campa

31 Proxy AdvisorsAre Voting Guidelines Ruling Your Business?By Gaizka Ormazabal & Allan L. McCall

37 Renewing the Boards Mission6 Items for the Top of Every Boards AgendaBy Jordi Canals

Why good governance Matters Boards need to close the rifts left by the crisis and be open to change, for the long-term success of business.

Are Voting guidelines Ruling Your Business? Gaizka Ormazabal and Allan L. McCall believe proxy advisors voting recommendations need to be handled with care. 31

6 items for the top of every Boards Agenda Jordi Canals casts a clearer vision of the firms purpose, calling for a drastic rethink of how the board can add long-term value. 37

eXpeRt insight50 Feedback tips for Less grumbling,

More growth Sheila Heen gives practical tips for improving the quality of feedback conversations between managers and subordinates.

editoRiAL4 Antonio Argandoa says its time we talk about

the elephant in the boardroom.

MY insight5 Jaume Ribera finds salient lessons on project

management from the construction and expansion of the Panama Canal.

6 Paul Druckman wishes integrated reporting would be seen for what it is: the story of how your company creates value.

eARLY insight7 Most attractive markets for food and beverage

exports; the New York Times publisher on embracing a mobile future; adaptability as a key leadership trait; at what point does an emerging country take off?

peRsonAL insight

BUsiness insight66 sustainability at Any price?

How can Henkel achieve its bold targets without hurting operating profits?

WideR insight71 swimming Against the tide

Edward Sinclair knows theres no room for negativity or complacency on the hard path to greatness in whatever your field.

LAst insight 76 strategy thats off the Chart

Massimo Maoret returns to the timeless wisdom of Igor Ansoff, the father of strategic management.

eXpeRt insight

how Fast Fashion Works: Can it Work for You, too?

Bringing Microsoft to the WorldCsar Cernuda, President of Microsoft Asia-Pacific, discusses the shift from PCs to devices and services. 45

Felipe Caro and Vctor Martnez de Albniz reveal the operational keys behind the fast-fashion business model..58

second QuARTeR 2014

issUe 21

Recommendations to Meet Future governance Challenges Jay W. Lorsch admits that while there have been positive changes in boardroom practices over the past 25 years, there is still work to do.15

transparency, a Rising trend in Listed Companies Jos M. Campa explains the trend toward greater transparency and an expanded role for shareholders. 24

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4editorial

ieseinsight

reading this issue of IESE Insight magazine, I was reminded of the parable of the six blind men and the elephant. Each one felt a different part of the animal and came to his own conclusion. For the one who touched the tail, the elephant was like a rope; the leg, a tree; the tusk, a spear; the trunk, a snake; the side, a wall; the ear, a fan. All were partly right, but unless they put their distinctive perspectives together, they were also all partly wrong.

Corporate governance is a similar beast. Since the onset of the global financial crisis, various pundits have proclaimed what the problems are and the solutions needed to fix them whether say-on-pay, shareholder activism, proxy advisors and so on. They may be right, and the regulators seem to

think so. But as our authors reveal, there is more to the story.Our dossier helps to fill out the picture of corporate governance,

adding flesh to what is often a bare-boned treatment of the topic. They bring rich perspectives on mission and values, leadership development and transparency, urging caution on the outsourcing of proxy voting and warning of the unintended consequences of seemingly progressive actions.

Elsewhere in the magazine, Sheila Heen tackles another beast the dreaded annual performance review explaining how each side approaches the process from different standpoints and suggesting how each can learn from the feedback of the other.

We also present multiple perspectives on innovative business models: Felipe Caro and Vctor Martnez de Albniz reveal the logistics secrets of Zara and other fast-fashion businesses; Csar Cernuda discusses Microsofts shift from products to services under its new CEO; and our case study on Henkel highlights another key piece of corporate governance today: sustainability strategies.

Taken together, readers will be able to talk more knowledgably about the elephants in their boardrooms.

SEcOND QUARTER 2014

ISSUE 21

E-mail: [email protected]/review PRICE PER EDITION 18/$25

2014 IESE Insight is published 4 times a year by IESE Business School, University of Navarra. ISSN 2013-3901. Legal Deposit No. B-14089-2010. The opinions expressed in this magazine and associated website (ieseinsight.com/review) are solely those of the authors. The contents and elements of this magazine and associated website are licensed for the individual use of authorized subscribers on a limited basis for noncommercial, personal purposes only; commercial use is prohibited. All rights reserved. No part of this publication may be reproduced, totally or partially, or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system, without prior written permission of IESE Business School, University of Navarra. For our latest subscription offers, visit ieseinsight.com/subscriptionFor queries regarding the use of articles and related material, e-mail [email protected]

Antonio Argandoa

The Elephant in the Room

Av. Pearson, 2108034 Barcelona, SpainTel.: +34 93 253 4200

Camino del Cerro del guila, 3Ctra. de Castilla (M-500)28023 MadridTel: +34 91 211 3000

165 W. 57th St. New York, N.Y. 10019 U.S.A. Tel.: +1 646 346 8850

www.iese.edu

There is more to governance than meets the eye

4 second QuARTeR 2014

editorial director emeritus Antonio Argandoa

editorial boardProf. Antonio DvilaAccounting and Control, Entrepreneurship

Prof. Fabrizio Ferraro Strategic Management

Prof. Philip MoscosoProduction, Technology and Operations Management

Prof. Javier QuintanillaManaging People in Organizations

Prof. Julin VillanuevaMarketing

managing directorGemma Golobardes

managing editorJordi Navarrete

editorsJordi NavarreteCintra ScottPhilip Seager

assistant editorsIvie EdosomwanMarta PeretEnric Rodon

editorial contributors Nicholas CorbishleyCarlos MillaJavier MoncayoDavid OliverLydia SmearsGemma Tonijuan Natasha Young

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layoutJavier M. Len

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advertisingIESE Business School, University of Navarra Av. Pearson, 2108034 Barcelona, Spain Tel.: +34 93 253 4200 E-mail: [email protected]

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My insiGht


The historic construction of the inter-American waterway and its recent expansion offer salient lessons on project management.

THIS SUMMER MARKS the 100th anniversary of the open-ing of the Panama Canal, considered the riskiest, most technologically complex project of its time. The effort now under way to expand this corridor, like the original plan to build an Atlantic/Pacific shortcut, provides salient lessons on managing grand-scale projects.

One has to remember that in the late 1800s, the sci-entific management of projects was something new. The Frenchman Ferdinand de Lesseps, riding high on pulling off the Suez Canal, aimed to repeat this feat in Panama. In the end, it bankrupted him, and the United States had to step in and finish what hed started.

In 1879, a decade after Suez, an International Congress was organized in Paris to entertain proposals for the Study of an Interoceanic Canal at Panama. De Lesseps plan to construct another Suez-style, sea-level canal without locks won majority backing among the 136 delegates present only 19 of whom were engineers.

In 1880, de Lesseps estimated the project would cost 658 million francs and take eight years to complete this was before any surveys had been done or any excavation work began. Within a few years, he had to admit defeat. With insufficient capital, the company was declared bank-rupt in 1889. Apart from the technical difficulties not to mention charges of financial corruption later leveled against de Lesseps one of the biggest obstacles proved to be the wet tropical work conditions, causing tens of thou-sands of laborers to die from malaria and yellow fever.

De Lesseps failure underscores the importance of careful planning and risk analysis prior to the start of any project. A gung-ho committee is no substitute for a proper study, with the technical aspects determined by experts.

In U.S. hands, the Panama project had three chief en-gineers: John Findley Wallace, John Stevens and George Washington Goethals. Stevens was the foremost civil en-gineer of his day, having accomplished the Great Northern Railway across the Pacific Northwest of the United States. He immediately applied his expertise to build a railway to cart away the excavated materials. Crucially, it was Stevens who finally calculated that a sea-level canal without locks was impossible, and he shifted to an elevated series of locks and dams, which ultimately saved the project.

by Jaume Ribera

Panama Canal: Hits and Misses

Jaume ribera is a professor of Operations Management at IESE and holder of the CEIBS Port of Barcelona Chair of Logistics.

Stevens was also the first to take the working conditions seriously, understanding that humanitarian concerns were as vital as scientific management to the projects success. He enlisted specialized physicians to treat the malaria and yellow fever, while also introducing an entertainment and food space for the workers, which boosted their flagging morale.

There are two takeaways here: first, the need to create safe work environments; second, the importance of break-ing down complex projects into activities that can be dele-gated and understood by those in charge of executing them.

Theres no substitute for careful planning and risk analysis by experts.

A century later, these lessons appear not to have been learned, as evidenced by problems with the canal expan-sion planned to be completed for the centennial. A group of companies, led by Spains Sacyr, won the bid to construct new locks based on high technical credentials and a bud-get lower than expected. However, time has revealed the shortcomings of awarding projects to the lowest bidder, with cost overruns leading to a bitter dispute and a stop-page of works until Panama coughed up more funds.

This highlights another key point: When risks are shared between the project tenderer and deliverer, their interests are better aligned and greater efforts are made on implementation and, when problems arise, joint resolu-tion. There are fewer legal battles and less finger-pointing over who should pay for things that were either poorly de-fined or not properly costed out by one side or the other.

In the case of the latest dispute, a temporary deal was struck, but the completion date has been put back to at least late 2015. When that day comes, the canal should be able to accommodate much larger and wider container ves-sels, doubling the traffic passing through the channel and with it world trade.

Project management is not so much a miracle as the naysayers once said it would take to complete the Panama Canal under de Lesseps but rather a science for which executives need to make sure they are fully prepared.

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My insiGht

ieseinsight6 second QuARTeR 2014 issue 21

Far from being a mindless exercise, integrated reporting needs to be seen for what it is: the story of how your company creates value.

MANY YEARS AGO, I found myself in a strange situa-tion in which my company was growing dramatically yet at the same time we were running out of cash. I realized, probably too late, that the sales director was manipulat-ing the terms of payment in order to get orders. That was because our Key Performance Indicators (KPIs) had been set around sales, but not around sales in the context of the overall viability of the business. We nearly went under.

That taught me a valuable lesson I will never forget: Reporting does influence behavior. Too often we treat re-porting as a mindless compliance exercise, rather than as something that actually does influence behavior, in posi-tive or negative directions.

Given its influential role, corporate reporting needs to be seen for what it is: a tool for creating a more finan-cially stable, sustainable environment for our businesses, for our societies and for the world. It is not about piling another burden on business; its about reporting that in-tegrates three key areas.

The first area deals with the kind of information con-tained in traditional financial statements the financials, infrastructure, fixed assets and so on. The second area en-compasses environmental and social concerns. The third area includes intangibles, such as intellectual property, branding and all the softer aspects of a business that are harder but are no less crucial to quantify. These three areas cover the full breadth of what a company should be reporting and what investors and others should be most interested in knowing. Corporations need to put metrics, or at least attempt to clarify their performance, against these three areas. This is integrated reporting. It tells the story of how your company creates value.

Unfortunately, for some companies, its just that: a story; a piece of marketing. I prefer to think of integrated reporting as the doorway to the strategy of a company.

An integrated report is a concise communication of how an organizations strategy, governance, performance and prospects demonstrate the creation of value over the short, medium and long terms. Conceived this way, cor-porate governance serves not just as a check or oversight but as a proactive, structured mechanism that supports a companys ability to create value in the short, medium

by Paul Druckman

Does Your Board Grasp Its Role?

Paul druckman is the CEO of the International Integrated Reporting Council (IIRC), a global coalition dedicated to seeing integrated reporting embedded into mainstream business practice as the corporate reporting norm. He gave the closing address at the 2nd Annual Board of Directors Forum organized by IESE Madrid in April 2014.

and long terms. Boards need to grasp this.Moreover, good governance is about quality, not quan-

tity. When I see reports of more than 100 pages, I start to struggle. What these companies are doing is simply bring-ing together a lot of compliance data the sustainability report, the CSR report, the financials and producing one massive document. Certainly combined reporting is a first step in the right direction, but as integrated reporting becomes more advanced, the communication should be-come more concise and relevant no more than 20 pages. Its better reporting, not more reporting.

Integrated reporting is the doorway to the strategy of a company.

The more corporate reporting is able to distill the breadth of a companys value-generating activities, the more useful it becomes to investors. Indeed, it condi-tions the types of investors you attract. Recent research among U.S. listed companies has found that those com-panies that reported broader than just the requisite com-pliance data attracted investors who were less fixated on quarterly earnings and who tended to take a longer term, stewardship perspective of the firm.

Over the past 12 months, I have heard quite a lot of talk about stewardship coming from the investor communi-ties in Canada, Japan, the Netherlands, South Africa and the United Kingdom. Even Google, I discovered, included this in its SEC filing before going public: A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half-hour. This is significant.

For me, this marks quite a staggering change from when I went to business school and first learned about corpo-rate governance. I think this view of governance which encompasses corporate citizenship, ethical responsibili-ties, accountability and fairness is an idea whose time has come.

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-11%

17%

Water &non-alcoholicdrinks

Beer

Sugar & confectionery

Highalcoholdrinks

Fishproducts

Wine

Dairyproducts& eggs

Bakery & cereals

Fats& oils

Meatproducts

Hot drinks & spices

Fruit &vegetables

USA

USA

USA

USA

USA

FRANCE

RUSSIA

NETHERLANDS

NETHERLANDS

NETHERLANDS

-8%

-0.5%

USA

USA

CHINA

CHINA

CHINAINDIA

GERMANY

FRANCE

GERMANY

GERMANY

GERMANY

GERMANYITALY

GERMANY

GERMANY

SINGAPORE

UK

UK

UK

123

123

USA

USAJAPAN

JAPAN

JAPAN

SWEDEN

84%-8%

-1%-15%

-9%

-7%

123

123

123

123

123

123

123

123

123

123

-7%

-0.5%

-7%GERMANY-12%

-6%

19%

17%

7%

0.6%

2468101214 0 $USB

-7%-6%

-10%

-1%

-0.5%

0.5%

17%

5%

-8%USA

MOST ATTRACTIVE FOOD & BEVERAGE MARKETSThe top 3 importers in each category, by $ value.

Year-over-year changesRate at which imports grewRate at which imports fell

18%

3%11%

4%

0.3%

0.5%

7%

19%

34%

QUICK KNOWLEDGE. THINKING AHEAD.earlyinsight

The Vademecum on Food and Beverage Markets 2014 was overseen by IESE Prof. Jaume Llopis and coordinated by Mara Puig and Jlia Gifra of IESEs Industry Meetings Department, in collaboration with a Deloitte team led by Fernando Pasamn. Read A Practical Guide to Food and Beverage Exports at ieseinsight.com.

Pablo Isla, chairman and CEO of the Inditex fashion retail group most famous for Zara, shares his secret for success during his keynote address at the

graduation ceremony for the MBA Class of 2014 at IESE Barcelona. Read more about Inditexs fast-fashion business on pages 58-65 of this magazine.

Just like success, happiness cannot be pursued; it is rather the consequence of our actions. Therefore, if we are

capable of passion and commitment, of nurturing our entrepreneurial spirit, of working hard but humbly, and

doing all of these things responsibly, we will have boughtourselves our surest ticket to happiness,

and by extension, to success.

When IT coMes To BeVerages, the United States is the top importer, while Japan imports the most food products, mainly meat, fish, cereals and baked goods. Other Asian countries that are significant importers of food and beverage products are China, India and Singapore, while demand in Europe is highest in France, Germany, Italy, the Netherlands, Russia, Sweden and the United Kingdom. These are some of the findings of the latest Food and Beverage Attractiveness Index, a useful tool for businesses to analyze evolving market condi-tions and set their export strategies accordingly. With 82 countries ranked, the index monitors consumption habits, demographic trends, short-ages or surpluses and other vital factors that companies need to know as they seek to internationalize their trade in this sector.

TRADE TRENDS

The Ripest Markets

ieseinsight 7 ISSUE 21 SECOND QUARTER 2014

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ChAnging RoLes ARoUnd thRee tiMes dURing YoUR CAReeR, with just over eight years in each role, seems to be the optimum for developing adaptability. So says a study of high-level general managers, finding that executives with more varied career histories tend to become more adaptable as a result.

Being able to respond effectively to new contexts, learn new skills and rapidly deploy them to solve unfamiliar problems is becoming a vital competency in todays ever-changing marketplace. This is made easier if executives have been exposed to a variety of situations and individuals over the course of their careers. Several factors help to develop this.

For one thing, working as an executive assistant early in ones career gives early training in being more adaptable. By shadowing senior managers, assistants observe how these leaders deal with changing circumstances, and this in turn fosters their own learning as they rise through the ranks.

Corporate programs aimed at growing high potentials also help, but they need to be managed carefully. For example, rotating managers around the organization may be helpful for exposing managers to a wide variety of situations but not if the changes are too frequent. Executives need adequate time to settle into each new role but not so much time that they become complacent. Its a tricky balance to get right.

In aiming for adaptable leaders, companies may need to adapt themselves, thinking twice about individuals changing job-type too often, as those who stay in each role for relatively short periods of time benefit less from the experience.

Read the abstract Fostering Adaptability in tomorrows executives at ieseinsight.com.

Adaptability:A Vital competency When Does an

Emerging CountryTake Off?

WHERE BEST TO INVEST

indonesiA, the phiLippines, MeXiCo And tURkeY show the highest potential for meaningfully increasing private equity (PE) ac-tivity in the near future, with Geor-gia standing at a critical juncture in the development of its investment infrastructure.

So finds the latest Venture Capital and Private Equity Country Attractiveness Index prepared by IESEs Center for International Finance, in conjunction with EM-LYON Business School, to help investors identify the countries with the greatest potential for investment.

Analyzing the socioeconomic data of 118 countries, the authors discover a strong link between their attractiveness scores and actual PE activity. They determine that a country with approximately 45 index points or more seems to mark the turning point when

PE activity comes alive. Georgia, rising eight places and with an index score of 45.9, is considered increasingly attractive, stay alert.

While the BRICs (Brazil, Russia, India and China) remain the dar-lings of investors, the index reveals several other countries whose medium-term prospects show just as much, if not more, promis-ing development. Besides those mentioned, the authors highlight Chile, Colombia, Estonia, Finland, Lithuania, Malaysia, Morocco, Oman and Peru.

This is not to say that all these countries boast ideal conditions for investors. Indeed, many of these countries still lack certain key drivers of the six identified by the authors as necessary for attracting and protecting investments. But what they do afford is a chance for early investors to gain a toehold before these markets take off.

Read more at ieseinsight.com and see the Venture Capital and private equity Country Attractiveness index 2014 at http://blog.iese.edu/vcpeindex.

HIGH RANK LOW RANK

early insight


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Steelcase researchers have identiied 8 dierent structural models of innovation within organizations, each with its own implications for how to use space to improve the speed and outcomes of innovation eorts. Simply stated, the right spaces make innovation work.

To read more learn more, visit www.steelcase.eu/innovate

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How Stereotypes Affect TeamworkWorkIng WITh colleagues FroM oTher counTrIes is not always easy. A study of U.S., Mexican and Indian engineers working together on a common project found stereotypes led to misunderstandings and commu-nication breakdowns that threatened the viability of the collaboration.

The Mexican engineers, fearing that others regarded them as not smart enough to come up with new

ways of doing things and likely to spend all day talking, deliberately did the opposite, believing this would subvert the stereotype.

Their plan backfired: the U.S. engi-neers complained that the Mexicans were always trying to come up with new procedures and were missing out on the expertise of others since they never spent any time talking with experienced colleagues.

The fact that the engineers relied on e-mail, phone calls and messaging may have contributed to everyone falling back on stereotypes. In the ab-sence of face-to-face encounters, peo-ple invent their own reality. As such, managers of multinational companies should allocate time and budget for global partners to visit each others workplace, learning how it actually is rather than how they think it is.

Occupational Stereotypes, Perceived Status Differences and Intercultural Communication in Global Organizations, by IESEs Carlos Rodriguez-Lluesma and Paul M. Leonardi of Northwestern University, was published in Communication Monographs. Read the abstract Beware of stereotypes When Working cross-culturally at ieseinsight.com.

WORKING CROSS-CULTURALLY

Read the abstract The return of the consumer, based on a new book by IESE Prof. J.L. Nueno, at ieseinsight.com.

ITALY

17%

SPAINFRANCE

RUSSIA

UNITEDKINGDOM

GERMANY

2004 2012

38%

18%

33%

20%

30%

BARGAIN SHOPPING IN EUROPELow-cost (value) retailers sales as a percentage of total apparel-industry sales, in 2004 and 2012

22%8%

31%

20%

6%25%

NEW RETAIL STRATEGIES

Consumers Wont

desPITe The gaIns ThaT The euroPean reTaIl secTor has experienced over the past decade, companies need to adapt to deal with post-recession realities. Cautious consumers show no signs of going back to pre-crisis shopping patterns.

The main retail channels in danger of extinction are small, inde-pendent stores located far from main shopping thoroughfares and malls in the city outskirts. There is a general shift away from sales channels that require a large investment in real estate.

This is not to say that physical stores have no future. Rather, they need to be combined with a digital presence, integrating online, mobile and social channels. Click-and-collect stores, pop-up stores and shoppable windows are examples of how online and offline channels can work together profitably.

Accept Returns

early insight

ieseinsight10 SECOND QUARTER 2014 ISSUE 21

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too oFten, pResentAtions FAiL in the deLiVeRY because they dont follow a clear path to a concrete call to action. Follow these tips for planning and delivering persuasive presentations that get results.

knoW WhAt YoU WAnt. Before thinking about content, start by thinking about the outcome you hope to achieve. Win YoUR AUdienCe. Make sure you understand both sides of the argument. Prepare ethical and emotional as well as logical appeals, and gather a variety of evidence to support your argument.BeneFits & oBstACLes. Consider the strategic, personal and business be-nefits of the audience doing what you propose, and what might prevent them. Choose the top three benefits and find supporting evidence for each.BUiLd YoUR ARgUMent. Successful rhetoric is built on a tried-and-testedstructure.

the grabber. Grab the audiences attention with an anecdote, a ques-tion, a startling statistic or a thought-provoking quotation.

the Message. Follow the grabber with a one-line statement that suc-cinctly tells the audience what your presentation is about.

signposting. Signposting lays out the skeleton of the argument for the audience.

Benefits 1-3. Remember to focus on benefits rather than features. At least 75 percent of your presentation should be dedicated to developing your three main points.

Closure. This section of your presen-tation is crucial. Sum up your main points in one sentence and give your call to action.

deLiVeRing Like A pRo. Public speaking is a performance. Having a clear struc-ture and lots of practice beforehand will help to lighten the mental load.

Time to Walk the TalkSALES NETWORKS

The survey was led by IESEs Cosimo Chiesa and Julin Villanueva. Read the abstract sales networks: A Little planning Would go a Long Way at ieseinsight.com.

Read the abstract how to persuade Audiences to Action at ieseinsight.com.

PresentationsThat Deliver

We are going to produce a newspaper in print for as long as people want it. But the one

thing we know is that we have got to continue to adapt and change.

Increasingly our traffic is coming to mobile. The question is: How do we

adapt to these new formats in a way that does not diminish

the quality journalistic experience?

Arthur o. sulzberger, Jr., chairman and publisher of The New York Times, spoke on these themes during a Global Leadership Breakfast at IESEs New York Center.

ALthoUgh 83 peRCent of companies surveyed say they place a strong emphasis on attracting customers, 35 percent do not currently offer any incentives to encourage their sales teams to bring in new customers. Surprisingly, just 36 percent of the companies surveyed have an established target for customer retention, loyalty or recovery, despite three out of four claiming they make an effort to hold on to their existing customers. Whats more, almost half of them still do not gauge their level of customer loyalty, and only a third have some type of loyalty program in place.

Your sales efforts are focused on

Attracting customers Retaining customers Recovering lost customers

Do you currently offer any incentives to encourage your sales teams to bring in new customers?

6535

%yes no

Do you have an established target for customer retention, loyalty or recovery?

36

64%yes no

83%75%

21%0 100

early insight


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BUSINESS SCHOOL IN THE WORLD FOR EXECUTIVE EDUCATION Financial Times, May 2014 2

BE THE KEY TOYOUR COMPANYSGROWTH

JOIN IESES PLD. MOVE FORWARD IN YOUR CAREER.

www.iese.edu/[email protected]

IESEs Program for Leadership Development (PLD) is an interactive learning experience designed to provide a solid foundation in business.

Its unique holistic approach to enhancing business knowledge and leadership capabilities will improve your performance and shape you into a well-rounded executive ready to move forward in your career.

You will collaborate with a pool of high-caliber participants and faculty members to develop a personalized Executive Challenge and a take-home agenda to ensure continued development.

With editions in Barcelona, New York, Munich and Sao Paulo the PLD is the definitive step toyour career development.

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dossierinsight


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Boards need to close the rifts left by the crisis and be open to change, for the long-term success of business.Illustrations by RAUL ARIAs

15 How Boardroom History Is Writing Its FutureRecommendations to Meet Future governance ChallengesBy Jay W. Lorsch

24 The Age of Activismtransparency, a Rising trend in Listed CompaniesBy Jos M. campa

31 Proxy AdvisorsAre Voting guidelines Ruling Your Business?By Gaizka Ormazabal & Allan L. Mccall

37 Renewing the Boards Mission6 items for the top of every Boards AgendaBy Jordi canals

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By Fernando Pealva

Corporate governance has come in for a bashing lately, ever since the global financial meltdown of 2007-08. Yet even before then, governance short-comings were already painfully apparent during the dot-com boom-and-bust of 2000 and the accounting scandals of 2001-02. And thats just talking recent history. If we go all the way back to the 1600s, the Dutch East India Company con-sidered the worlds first multinational corpora-tion and the first to issue stock also endured perhaps the worlds first governance crisis ow-ing to corruption, and by 1800 the company went bust. As the saying goes, Those who do not learn from history are destined to repeat it.

Lest we find ourselves having this same con-versation in a few years time, I recommend you read this IESE Insight dossier and reflect on its lessons for your organization.

To be fair, corporate governance today is better than it used be. Progress has been made. In line with wider social trends revolutionizing the business world, there is a growing sense of people empowerment, with shareholders hav-ing more of a say over company affairs. Boards are more conscious of their social responsibilities. Accountability is up; rubber-stamping whatever the great and mighty CEO says is down.

True, some of these moves have been reac-tive. Whats needed now is a deeper reflection on the conceptual framework of corporate gov-ernance to make sure the changes stick. We need to step back and ask ourselves: What should regu-lators and firms address next, which goes to the very heart of corporate governance?

Harvards JAY W. LoRsCh opens the discussion by reflecting back on 25 years of governance his-tory to make four recommendations that must be addressed for there to be any progress on meeting the corporate governance challenges of the future. He questions some of todays cat-egorical thinking: that its always better to have independent directors serving shorter terms, for example, or that we need to nix hefty pay. Lorsch reminds readers that the mere fact of in-dependence counts for little without equal parts

Governance Matters

We need a deeper reflection on the conceptual framework of corporate governance.

wisdom and experience; and until we stop be-lieving that executives are incapable of doing anything without first being bribed for it, then debates over pay will remain just as vexed.

Next, Jos M. CAMpA elaborates on one of the hallmarks of good governance: transparency. The IESE professor and director of Investor and Analyst Relations at Santander Bank calls for more openness at three levels: between manage-ment, boards and society. Clear financial report-ing is a given; companies need to focus on being just as clear about business risks, explaining decision-making processes, justifying executive compensation and coming clean on potential conflicts of interest, so that everyone can exer-cise their voting rights without hidden agendas.

That said, my IESE colleague in the Depart-ment of Accounting and Control, gAiZkA oRMAZA-BAL, and ALLAn L. McCALL, of Stanford Universitys Graduate School of Business, point to research theyve done on proxy voting to question wheth-er you can have too much of a good thing. No one doubts that disclosure, transparency and ac-countability are good things but blindly trust-ing proxy advisor recommendations is not neces-sarily the neatest answer. As other nations look to the U.S. Securities and Exchange Commissions regulatory choices as a benchmark, the debate raised by the authors on the U.S. proxy advisory industry is worth following.

Rounding out this dossier, IESE professor and dean JoRdi CAnALs casts a clear vision of the firms overarching purpose, rooted in a strong sense of mission and values. With this in mind, he sets out six agenda items for the board that will add long-term value to the company it serves. For Canals its not just a question of getting a few er-rant companies back on track but of safeguarding the future of capitalism itself.

Theres no one-size-fits-all solution. But hopefully after reading this dossier, you will be one step closer to resolving the particular gover-nance challenges you face.

fernando Pealva is IESEs Secretary General and professor of Accounting and Control.

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Boardroom: the word alone conjures up grand visions of power, wealth and privilege. The boardrooms core the symbol of its power is a mas-sive, highly polished table around which the directors are supposed to make the decisions that govern corporations, impacting the live-lihoods of many. It is the throne room of the corporate worlds potentates.

At least, thats what people think. A quar-ter century ago, in the book Pawns or Potentates:

The Reality of Americas Corporate Boards, my coauthor Elizabeth MacIver and I found that boards were acting more like pawns and not so much as the potentates they were legally in-tended to be. More often than not, real power over corporate affairs and major decision-making was being wielded by the CEOs, pos-ing serious problems for the boards that were ostensibly meant to oversee them.

There have been significant, positive chan-ges over the past 25 years. In spite of and to

By JAY W. LoRscH

Recommendations to Meet Future Governance Challenges

HOW BOARDROOM HISTORY IS WRITING ITS FUTURE

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some extent because of the periodic crises that have occurred during this time, boards are now more seriously engaged and working harder to fulfill their duties. Thats the good news.

The other news is that there is still work to do. This article outlines the major problems that boards have faced over the past quarter century and solutions proposed to overcome them. I warn about the negative, unintended consequences of some of these solutions. And I offer my views on how to meet future governance challenges within the wider con-text of business.

how we got to where we are today: the norms of the 1990sTo begin, I should note that in the United States the geographic focus of my studies it is the boards that have the legal authority, as enshrined in Delaware law. In other words, the boards are in charge. They can then choose to delegate their authority to manage the com-

pany to its officers. In practice, boards always did, and still do, make such delegations. Full-time employees with the time and knowledge to manage are the ones who run the company.

That being said, boards need to retain enough power to question and oversee CEO decisions. Board solidarity and building a strong relationship with the CEO are two sources of board influence. However, these sources of power were limited by the culture and norms of the 1990s. In the United States, these limitations included:

LiMited tiMe. Most board members had other full-time jobs and some served on several dif-ferent boards at a time.

LiMited knoWLedge & inFoRMAtion. To an im-portant extent, boards limited knowledge and information was due to the sheer size and pace of the businesses under their charge, in addi-tion to the limited time mentioned above.

LiMited eXpeRienCe. Independent directors usually had limited experience in the com-panys specific line of business, which forced them to learn on the job.

inFoRMAtion AsYMMetRY. In most board-rooms, the management teams not only had greater knowledge of the issues but they also controlled the information that the directors received.

LACk oF CLARitY ABoUt BoARd goALs. Certain directors believed that the primary purpose of a company was to create value for sharehold-ers; others believed that companies should have broader goals, serving not only share-holders but also customers, employees and their communities. Because such important distinctions were never clarified, decisions wound up being based on fundamentally di-vergent premises within the same board.

there have been significant, positive changes in boardroom practices over the past 25 years. However, there is still work to do, says the author, whose expertise in corporate governance matters was tapped for lawsuits involving the Tyco and Enron fiascos at the dawn of this new century. Drawing on decades of research and experience, the author outlines the major problems that boards have faced over the past quarter century and the solutions proposed to overcome them.

He warns of the negative, unintended consequences of some of these solutions, many of which were not thought through carefully and may be based on false premises. Finally, he offers four recommendations for directors, CEOs, shareholders and other stakeholders on how to meet future governance challenges within the wider context of business. Put simply, there needs to be open communication between all parties and a consensus on the ultimate purpose of the firm.

eXeCUtiVe sUMMARY

In practice, boards can choose to delegate their authority to manage the company to its officers. But they need to retain enough power to question and oversee CEO decisions.


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stRong noRMs. The presence of a strong coali-tion of board members to counter the power of the CEO was not the norm at the time. Dir-ectors subscribed to the notion that it was inappropriate to criticize the CEO in board meetings or to have discussions without the CEO present.

CoUnteRVAiLing poWeR oF the Ceo. The CEO and the executives reporting to the CEO served as the boards primary sources of in-formation. Since the board chair and the CEO were normally one and the same, it was usually the CEO who set the agenda and controlled the discussions of board meetings.

a new Paradigm is born?The diagnoses of these boardroom problems of the 90s found willing listeners, leading to calls for change. Among the changes developed in the United States and the United Kingdom were a set of agreed best practices, which in-cluded: n Smaller boards to facilitate group discus-sion.

n A majority of independent directors.n Meetings without the CEO present. Direc-tors were encouraged to hold executive ses-sions. They also began to feel comfortable speaking to each other informally between meetings.

n Board leaders who were not also the CEO. n Independents controlling the selection of new directors.

n Audit, compensation and corporate govern-ance committees in which directors met without the CEO or the top management present.

n A sharpened focus: The board focused on the approval and oversight of corporate strat-egy, CEO performance and management development to assure a supply of future executives. Boards also evaluated their own performance and were supposed to ensure

that the company complied with applicable laws.

Granted, not all boards adopted these practi-ces simultaneously or quickly, and some in the United States did not do so until laws and regu-lations required them many years later.

Conversely, in the United Kingdom, the adoption of recommendations made by the Cadbury Report such as having a board chair who was not the CEO, adding independent and nonexecutive members, and establishing audit committees was swift and dramatic.

Yet even adopting best practices such as these did not solve all boardroom problems. Far from it.

crises at the dawn of the 21st centuryAt the beginning of the new century, two dif-ferent governance-related crises struck. The first was the bursting of the dot-com bubble in 2000. Many early-stage, newly listed public companies had yet to prove they had sustain-able business models. Although their subse-quent failures were blamed mostly on reck-less entrepreneurs and venture capitalists, in hindsight such failures were at least partially the fault of boards who wanted to attract pub-lic investors even before their companies had earnings.

A second governance failure was the wave of fraud and misleading accounting that oc-curred at companies such as Enron, Tyco and WorldCom. While the specifics of each scandal were different, all featured improper or fraudulent accounting practices and infla-tion of the compensation packages of senior managers. In the case of Tyco, a so-called in-dependent director was receiving question-able payments from the company. Notably, all these boards had a majority of independent directors, and they also had audit, compensa-tion and corporate governance committees. So what went wrong?

The diagnoses of the boardroom problems of the 90s led to a set of agreed best practices. Yet even adopting best practices did not solve all boardroom problems. Far from it.


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At the time, I had the dubious distinction of serving as a potential expert witness in law-suits involving both Tyco and Enron directors. After reading hundreds of pages of documents on both these cases, what struck me as a com-mon theme was that the directors remained in thrall to the CEO, regardless of the lip service being paid to the new boardroom paradigm emerging out of the 90s. Clearly, the goal of increasing the power of the board to counter the CEO had fallen short of the mark in these companies.

These corporate scandals generated mas-sive outcry from the public, media, business leaders and politicians alike. This led to the passage of the Sarbanes-Oxley Act in the United States in 2002, which imposed new re-quirements on the audit committees of boards and for the certification of financial reports by public-company CEOs and CFOs.

Despite complaints from senior manage-ment and board members that Sarbanes-Ox-ley was too onerous, there were no serious at-tempts to change or repeal it. In fact, within a few years, most directors and senior execu-tives with whom I spoke admitted that the

Jay W. Lorsch is the Louis E. Kirstein Professor of Human Relations at Harvard Business School, where he earned his doctorate in Business Administration. He is the author of more than a dozen books, including Back to the Drawing Board: Designing Corporate Boards for a Complex World and Pawns or Potentates: The Reality of Americas Corporate Boards, and the editor of The

Future of Boards: Meeting the Governance Challenges of the 21st Century. His business classic Organization and Environment, coauthored with Paul R. Lawrence, won Academy of Management and James A. Hamilton book-of-the-year awards. He recently collaborated with IESE on the Short Focused Program Value Creation Through Effective Boards held at IESE Barcelona in May 2014.

ABoUt the AUthoR

The belief that corporate boards were improving made the financial meltdown in 2008 particularly shocking. Many blamed bankers as responsible. But where were the boards of financial institutions at the time?

law had improved accounting and financial reporting for their companies. They felt the law gave audit committees clear responsibil-ity for overseeing the public accounting firms that audited them, which in turn improved corporate governance.

Also in response to the scandals, the New York Stock Exchange and the Nasdaq revised their listing requirements. Essentially both exchanges modified their rules to require that listed companies implement most of the pre-viously mentioned best boardroom practices.

The combination of the changed listing requirements and Sarbanes-Oxley added mo-mentum to the improvement of boards.

the financial crisis of 2008 and beyondThe belief that corporate boards were improv-ing made the financial meltdown in 2008 particularly shocking to those of us closely following corporate governance issues. Since the media, politicians and the public identi-fied those responsible as bankers or Wall Street, there was little public criticism of boards.

Yet where were the boards of financial in-stitutions at the time? Directors were appar-ently dependent on top management for in-formation about corporate lending practices. An underlying problem was that because of the drive to find independent board members, too few directors of financial firms had any depth of financial experience.

Although the Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States in 2010 focused on the regula-tion of banks and their officers in the wake of the financial crisis, the new law had two wider ramifications for corporate governance. The first was to allow shareholders under certain conditions to place nominees for board seats on the proxy statement of the company. This was intended to allow shareholders to have


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more of a voice in nominating directors for board seats, although its implementation was rather limited.

The second aspect of Dodd-Frank that af-fected governance broadly in the United States was its say-on-pay provision, which gave share-holders the right to vote on the compensation of senior executives, although the results were non-binding. The idea was adapted from a Brit-ish proposal that had existed for several years.

One may wonder how say-on-pay found its way into a law whose purpose was financial regulation. One reason was the shareholder and media outcry over executive compensa-tion being too large and unrelated to corpor-ate performance, with the pay for top execu-tives of financial institutions singled out as an egregious example.

25 years of Progress?This historical recap sets the stage for discuss-ing the future steps for continued improve-ment. That boards are doing a better job of governance today than they were 25 years ago seems indisputable. For example, directors now report that they understand the role they are expected to play and that they are focusing on the economic performance of their com-panies over the next two years or more. They also report that they have a high level of com-fort with the information they are receiving.

What remains problematic is the erratic and relatively unpredictable manner by which such improvements have been brought about. Negative unintended consequences of reforms have threatened the progress of corporate governance on several fronts. The following examples stand out:

sAY-on-pAY. In 2006 the U.S. Securities and Ex-change Commission introduced a requirement for public companies to report the compensa-tion of their senior executives. The theory was that disclosure of such information would help

to curb excessive pay. It was not to be. Instead what has happened is that senior executives have used the knowledge of their peers com-pensation packages to argue for more pay for themselves.

MAJoRitY oR LARgeR pRopoRtion oF independ-ent diReCtoRs. The intention of having more independent directors was to reduce potential conflicts of interest. Outside directors were to act with complete loyalty to their companies. But independence has had the unintended consequence of creating more or a majority of board members lacking deep experience in a companys industry or line of business.

eLiMinAtion oF stAggeRed BoARds FoR shoRt-eR teRMs. The advocates of doing away with staggered boards argued that shorter terms provided shareholders with a greater oppor-tunity to replace directors whenever they believed it was desirable. To me what is more important is to have directors with knowledge and experience. Serving longer terms fos-ters this knowledge and experience, thereby strengthening the argument for retaining staggered boards.

I believe there are two major reasons for such negative unintended consequences. First, boards are part of complex systems. Un-fortunately those who propose a particular change, frequently in reaction to a sudden pub-lic outcry, often do not anticipate the poten-tial downsides of their proposals. Moreover, they may only understand and care about one part of the system as in the case of institu-tional shareholders who believe the best way to improve corporate governance is to grant themselves greater influence over corporate decision-making (see the sidebar The Rise of Shareholder Power).

These problems are compounded by mis-trust between directors and shareholders.

Boards are part of complex systems. Unfortunately those who propose a particular change, frequently in reaction to a sudden public outcry, often do not anticipate the potential downsides of their proposals.


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Shareholders interpret resistance to their proposals as veiled attempts by boards to en-trench their power, while directors believe shareholders are only out to protect their own rights and interests.

Meanwhile, some parties cling to the view that a corporations sole responsibility is to its shareholders, while others argue that the corporations purpose must be broader, con-sidering its long-term health and the value it adds to society as a whole. So long as disagree-ments persist over a businesss ultimate pur-pose, it will be hard to achieve consensus on future changes to corporate governance. Open discussions are required.

In my view, the most beneficial changes have emanated from boards and their advisers who

understand that governance is the result of hu-man relationships. Directors know firsthand why boards may have difficulty carrying out their responsibilities and they are well placed to come up with the solutions that eliminate or at least minimize these constraints.

four recommendations for the futureGoing forward, I see four things that must be addressed for there to be any progress on meeting the corporate governance challenges of the future.

1. A BetteR pRoCess FoR oVeRseeing eXeCUtiVe CoMpensAtion. Current problems related to ex-cessive executive compensation are to my mind

in many cases, the impetus for adopting best practices in the boardroom have come from direc-tors themselves, but institutional investors have also pressed for certain changes. They rallied for changes and limits to CEO power, seizing on the fact that leaders of public companies do not want to be embarrassed.

One of the earliest examples occurred in 1990, when two U.S. state pension funds wrote letters to the board of General Motors asking how the directors planned to handle the selection of a suc-cessor for then-CEO Roger Smith. When they did not receive a satis-factory response, the parties pub-licized the episode in The New York Times and The Wall Street Journal. Further, they exercised their right to sponsor shareholder proposals

and changed corporate bylaws. In the United States, there are

four salient examples of how insti-tutional investors have influenced boards in a decades time.

shoRteR teRMs. In 2009, 68 per-cent of directors served one-year terms, compared with 38 percent of directors in 1999.

MAJoRitY Voting. In 2009, more than half of all companies in the S&P 500 had a majority standard for un-contested board elections, up from the plurality voting of prior years.

sepARAtion oF Ceo & ChAiR RoLes. In 2009, 37 percent of S&P 500 companies split the chair and CEO roles, compared with 20 percent in 1999. Despite moves toward splitting the jobs, particularly in

the United Kingdom, I find the reasons for doing so can be based on knee-jerk reactions rather than on compelling evidence that it is better than leaving the two positions combined. I would argue that a competent lead or presid-ing director should be capable of striking the right balance between effective governance and lead-ership. Simply separating the roles without understanding the complexities involved is hardly the answer.

poison piLL. The number of S&P 1500 companies that maintain a poison pill a tactic that gives directors power to deter or prevent takeover bids continues to de-crease: 42.5 percent in 2007, 34.5 percent in 2008 and 27.5 percent in 2009.

SOURCE: Lorsch, J.W. Americas Changing Corporate Boardrooms: The Last Twenty-Five Years. Harvard Business Law Review 3, no. 1 (Spring 2013): 119-34.

the Rise of shareholder powerPushes for changes to corporate governance practices are increasingly coming from institutional investors.


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symptomatic of larger societal questions and cannot be fixed by mere disclosure or say-on-pay. I stand by what my coauthor Rakesh Khurana and I wrote in The Future of Boards a few years ago: Rethinking the nature of executive pay within the context of our larger economic and social system and the challenges we face may enable us to create a new model of compensation rooted in a more realistic recognition of the social context within which firms operate. It should, and can, rest on valid assumptions and fundamental val-ues that allow us to build a more inclusive and sustainable economic future one in which we dont have to bribe executives to do the duties we have entrusted to them.

2. MoRe diReCtoRs Who ARe Both independ-ent And knoWLedgeABLe. Most boards, espe-cially in North America but also in European countries, are now required to be made up of independent members. The problem is, most independent directors join boards with lim-ited prior connection to the company and its industry. As such, to be effective, boards must be good at educating their members and get-ting their knowledge base up to speed. A simple thing to do is make sure that directors are sent vital information in advance of board meet-ings with the expectation that they will digest it and come to the meeting fully prepared. This will help ensure that board meetings are more productive.

3. A ReeXAMinAtion oF stAggeRed BoARds. Over the past several years, many companies have eliminated staggered boards to the point where most directors, in the United States at least, are now elected annually. Does this lead to better governance? Some institutional shareholders, especially union and pension funds, believe it does. From their perspective, it is especially helpful in not allowing boards to become entrenched and block takeover at-tempts. But many directors have indicated that it took them a year or more to understand their companys business. Terms should be longer than just one year.

4. iMpRoVed CoMMUniCAtion BetWeen CoM-pAnies And Long-teRM shARehoLdeRs. Clearly the present methods of communication and dialogue between boards and shareholders are not adequate. Quarterly earnings calls

are all too often an excuse for stock analysts to probe for hints about short-term results. Shareholder proposals usually involve some means of harassing boards and limiting their power. Neither of these common means of communication between companies and their shareholders is very helpful for improving governance, yet these battles are likely to con-tinue unless other means are found to enable shareholders and directors to communicate in a more positive fashion.

In sum, communicating in a more positive fashion and agreeing on corporate purpose will be key to meeting the governance challenges of the 21st century. There is the question of who could convene such discussions. There are numerous possibilities from the stock ex-changes, to members of the legal community, to business leaders, to academics. Improving corporate governance more rapidly requires not only a more precise agreement about the purposes of the corporation, but also that the major actors involved in governance have a forum in which these issues can be explored and agreed upon together.

This article was adapted from Americas Changing Corporate Boardrooms: The Last Twenty-Five Years, originally published in Harvard Business Law Review 3, no. 1 (Spring 2013): 119-34, and is used with permission of Jay W. Lorsch. The following other works also informed this article:

n Lorsch, J.W., ed. The Future of Boards: Meeting the Governance Challenges of the 21st Century. Boston: Harvard Business School Press, 2012.

n Carter, C.B. and J.W. Lorsch. Back to the Drawing Board: Designing Corporate Boards for a Complex World. Boston: Harvard Business School Press, 2004.

n Lorsch, J.W. and E. MacIver. Pawns or Potentates: The Reality of Americas Corporate Boards. Boston: Harvard Business School Press, 1989.

to knoW MoRe


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SHAPING EUROPE AS A GLOBAL REFERENCE

KNOWING WHERE TO GO IN A

FUTURE WITHOUT MAPS.

GLOBAL ALUMNI REUNIONOCTOBER 30-31 , 2014

CENTRO DE CONGRESOS PR NC IPE FEL IPE MADRID

REG ISTER NOW: WWW. IE SE .EDU/GAR

Some of the confirmed speakers

Ren AubertinHAIER EUROPE

(CEO)

Nani Beccalli-FalcoGENERAL ELECTRIC EUROPE(PRESIDENT AND CEO)

Luis CantarellNESTL HEALTH SCIENCE (PRESIDENT AND CEO)

Patricia Ithau LORAL EAST AFRICA

(MANAGING DIRECTOR)

Ana MaiquesSTARLAB

(CO-FOUNDER & BUSINESS DEVELOPMENT)

David MillsRICOH EUROPE

(CEO)

Thomas RabeBERTELSMANN

(CHAIRMAN & CEO)

Julio Rodrguez SCHNEIDER ELECTRIC

(EXECUTIVE VICE PRESIDENT GLOBAL OPERATIONS AND MEMBER OF THE EXECUTIVE

COMMITTEE)

Kenneth Rogoff HBS

(PROFESSOR OF ECONOMICS)

Francisco Javier RuizDELOITTE IBERIA

(CEO)

Juan Miguel Villar MirGRUPO VILLAR MIR

(CEO)

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Transparency, a Rising Trend in Listed Companies

By Jos M.cAMpA

THE AGE OF ACTIVISM

Corporate governance is essentially a system of rules and procedures for regulating the relationships among various participants in a company from the executive management team and board of directors, to shareholders and other stakeholders. Many people erroneously make the companys relationship with its sharehold-ers the chief concern, when in fact corporate governance should encompass relationships with all groups affected by the companys ac-tivities, whether directly (shareholders, em-ployees, creditors, service providers and cus-tomers) or indirectly (government bodies and other social actors).

The global financial crisis has revealed the inadequacies of many business practices,

prompting many companies to rethink the role of corporate governance. Although the specific way in which corporate governance is practiced depends on the company itself, legislators, reg-ulators, shareholders and societal stakeholders are exerting their influence in this post-crisis period, having realized the serious consequenc-es of bad governance. As I will explain in this ar-ticle, the trend is toward greater transparency and an expanded role for shareholders.

accounts getting clearerThe first priority of corporate governance is to have clear accounts. This means having con-sistent, comparable reporting criteria in order to provide a relevant, reliable picture of the companys financial activities, which can be

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confirmed by impartial third parties. Even though this seems pretty basic, many compa-nies reporting standards fall short, with the following deficiencies being the most common:UnCLeAR. All too often, the accounts of large, listed companies are overly complex. UnRepResentAtiVe. While the reports may be a faithful reflection of accounting activities dur-ing a fiscal year, they may reveal nothing about the risks taken to get there or the companys likely future evolution.LittLe stAndARdiZAtion. Certain accounting items may be arbitrarily defined.inConsistent. The accounting principles used may change over time as a result of a corporate decision or a new piece of legislation.inCoMpARABLe. One companys accounting criteria may be significantly different from anothers. This is especially true at the inter-national level.no gUARAntees. Although companies are obliged to have audits, no third-party audit can ever give full guarantees.

In spite of these flaws, there is some cause for optimism, with substantial progress made in the following areas:ACCoUnting & FinAnCiAL CRiteRiA. As noted previously, the application of certain account-ing and financial criteria can vary widely from

good corporate governance cannot guarantee that good decisions will always be made: running a business is fraught with risk and managers can and often do make mistakes. What good governance does do is ensure there is accountability and that decisions are taken in an appropriate manner. The

recent experience of publicly traded companies has shown that good governance requires both transparency and fluid communication between the major interest groups that is, between top management and the board of directors; between the board and shareholders; and between shareholders and society at large.

eXeCUtiVe sUMMARY

country to country, company to company. However, moves toward agreeing universal, global reporting standards are steps in the right direction. inteRnAL AUdits. Internal audits are getting more rigorous and compliance requirements have been raised.eXteRnAL AUdits. The penalties for negligence by external auditors have been raised signifi-cantly. Also, much greater attention is now be-ing paid to potential conflicts of interest. The independence of auditors who also provide consulting services to the same firm is increas-ingly being questioned and clamped down on following the wave of high-profile accounting scandals since 2000.AdMinistRAtoRs. Little by little, administrators are being required to present clearer accounts.

More transparent ProceduresGood governance is not just about presenting clear accounts that reflect the companys finan-cial activities. To ensure the clarity and consis-tency of its future accounts, there must also be transparency in a companys decision-making processes.

Admittedly, even with the best governance systems in place, there is no built-in assurance that good decisions will be made all the time: running a business is fraught with risk and managers can and often do make mistakes. Whether to relieve top managers or executives of their duties for a decision that results in a negative business outcome is an open ques-tion for shareholders. But from a governance point of view, the key concern is whether that decision was made in an appropriate manner, free from procedural bias. Governance en-sures there is at least accountability for those decisions.

Recent history underscores the need for much greater transparency as well as more fluid communication between the major stakehold-ers at three levels: between top management

Good governance is not just about presenting clear accounts. To ensure the clarity and consistency of its future accounts, there must also be transparency in a companys decision-making processes.


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and the board of directors; between the board of directors and shareholders; and between shareholders, or the company owners, and so-ciety at large. (See Exhibit 1.)

1. transparency between Management and the boardTo ensure robust decision-making, there must be healthy levels of trust between the top man-agement team and the board of directors, as well as between the individual members of the board. Some measures being taken to deepen this trust include:CoMMittees FoR stRAtegiC issUes. In addition to compulsory audit committees and the usual committees for appointments and remunera-tion, companies are increasingly setting up specialized committees to oversee such areas as strategy, risk, investment and technology.A heALthY distRiBUtion oF FUnCtions & BAL-AnCe oF poWeRs. There is a trend toward sepa-rating the chair and chief executive roles, so that the functions are not concentrated in the same individual. In the event that both roles are held by executives, the competencies called for in each position are being better defined. the gRoWing iMpoRtAnCe oF non-eXeCUtiVe AdViseRs. As the presence of non-executive board members or external advisers becomes more common, their role is expanding be-yond merely acting as an outside inspector or observer. In addition to evaluating risks, management biases and the suitability of de-cision-making processes, many are assuming the capacity to act and lead initiatives inde-pendent of the board chair. Some may also have the power to summon the board, introduce items onto the agenda and evaluate the chairs performance. hiRing, eVALUAtion & RepLACeMent oF the Ceo. These functions by far the most important responsibility of the board are generally be-coming more transparent, with more compa-nies thinking about succession planning.

2. transparency between the board and shareholdersTransparency between the board and share-holders extends beyond the obligatory presen-tation of audited accounts to include reporting on corporate social responsibility, environ-mental impacts, remuneration, risks and other aspects of business activity. For some regulated sectors, like banking, the reporting require-ments introduced in the wake of the global financial crisis have provoked a sharp rise in compliance costs, with JPMorgan Chase CEO Jamie Dimon recently stating in his annual letter to shareholders that the bank had spent billions and hired an additional 13,000 employ-ees just to keep up with regulatory issues and compliance. Boards are attempting to improve their communication with shareholders in the following areas:BUsiness Risks. Shareholders increasingly ex-pect to receive a risk-evaluation report from the board of directors. They want to know what could go wrong, why and which instruments the company has in place to manage those risks. Companies are also now openly discussing a much broader range of risks not just finan-cial or catastrophic risks but environmental or reputational ones as well. FUtURe pRospeCts. Accounts are a reflection of past actions and operations, not a forecast of what the company intends to do in the future. Shareholders and potential investors also seek information about a companys future activi-ties, management reflections on the environ-ment in which theyre operating and about their business priorities, and signs of any dark clouds gathering on the horizon.

There is an inherent tension between this need for detailed information about the compa-nys future plans and the impossibility of being able to predict the future. As such, future plans need to be flexible enough to accommodate any sudden changes in the business environment, while still offering some certainties for the

Companies have an undeniable impact on the societies in which they operate. As part of this, the concept of sustainability has assumed critical importance in all business activities. But what does it actually mean?


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Jos M. Campa is a professor of economics and finance at IESE Business School as well as Director of Investor and Analyst Relations at Santander Bank. He holds a masters and PhD in Economics from Harvard University, and is an expert on international finance and macroeconomics. He has taught at Harvard University, Columbia University, N.Y.U.

Stern School of Business and Complutense University of Madrid. He has also been a consultant to organizations such as the World Bank, the International Monetary Fund, the Federal Reserve Bank of New York and the European Commission. Between 2009 and 2011, he served as Secretary of State for Economic Affairs of the Spanish government.

ABoUt the AUthoR

course ahead to avoid too many nasty surprises for shareholders.deCision-MAking pRoCesses. Corporate gov-ernance is a form of delegated decision-making, with the board making decisions on behalf of the shareholders. For this reason, shareholders de-serve to know who is taking what decisions based on which criteria. Even though those who hold formal decision-making power may be quite dif-ferent from those who actually wield power and influence in an organization, shareholders must be able to know who needs to be held responsible for decisions taken.

Naturally, people make mistakes, and gov-ernance mechanisms should include some tolerance for mistakes, which are par for the course when it comes to risk taking and inno-vation. But accepting that boards may make mistakes is not to tolerate a lack of analytical rigor. Decision-making must not be allowed to get hijacked by a small minority who may only be serving their own interests rather than the greater good of the organization.

3. transparency between company owners and societyCompanies have an undeniable impact on the societies in which they operate. This impact in-cludes the generation of employment and eco-nomic activity, as well as the provision of goods and services to customers. It also includes indi-rect effects such as improvements or deterio-ration in the quality of life of citizens.

As part of this, the concept of sustainability has assumed critical importance in all business activities. But what does it actually mean?

First, it means having a solid business model aimed at generating stable, self-sustaining rev-enue streams that guarantee the firms long-term survival.

Second, it means taking ethical, social and environmental considerations into account when making decisions, so as to support the long-term development of the communities in which a company operates.

Both issues are interrelated, as consumers increasingly evaluate companies not only on what products or services they offer, but also on the methods they use to produce or sell them. Consequently, a growing number of companies have begun to report on their performance in the following areas:soCiAL & enViRonMentAL iMpACt. More annual reports feature sections dedicated to the firms impact on the communities in which it oper-ates. A similar trend is happening in the envi-ronmental sphere, with firms highlighting the environmental impact of their activities and integrating these reports with the financial statements.Risks. Transparency is a prerequisite of effec-tive risk management, founded on explicit communication.VALUes & LABoR pRACtiCes. Companies are coming under mounting pressure to make sure their supply chains are ethically managed, par-ticularly with regard to external suppliers and labor practices in far-flung locations. Compa-nies must be open and honest about the work-ing conditions not only of their own premises but of their suppliers in all the markets in which they operate.

Consumers and investors are now able to compare the performance of various compa-nies using publicly available indices that rate businesses according to ethical criteria and social indicators. Certain investors even base their investment decisions on such indices.

However, these indices are still in their in-fancy, making it difficult to track and compare data on ethical business practices across coun-tries. No doubt we will see greater convergence over coming years.

conflict ManagementOrganizational conflict, though inevitable, can be preempted and mitigated if companies are transparent about potential conflicts of inter-est and develop explicit procedures for dealing


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with them. This means publicly disclosing situ-ations in which such conflicts have arisen and suggesting how they will be tackled. There are three areas of conflict that, due to their preva-lence in business, deserve special attention.

ConFLiCts BetWeen shARehoLdeRs. The exis-tence of different types of shareholders raises the likelihood of them having different inter-ests, views and priorities about the companys future. Managing these differences is an essen-tial aspect of good governance.

The interests of large shareholders differ

from those of small retail shareholders. Some may wish to exercise their voting rights; oth-ers may prefer not to participate in governance issues at all.

For diluted shareholders who do not want to be active participants, they risk maintain-ing the status quo, simply rubber-stamping the opinions of management. In this case, gover-nance mechanisms need to encourage them to become more actively involved and engaged.

On the other hand, having too many activ-ist majority shareholders may lead to lopsided agendas, especially if these shareholders are also board members or wield undue influ-ence or sway over prominent board members. When this is the case, governance mechanisms need to disclose the existence of any alliances between large shareholders, as well as any fi-nancial, business or personal relationships between shareholders, board members or company executives.

ConFLiCts BetWeen eXeCUtiVes & shARehoLd-eRs. When it comes to conflicts between ex-ecutives and shareholders, the biggest sticking point concerns remuneration a key motiva-tional lever that has been shown to affect man-agerial decision-making in both positive and negative directions. The questions on execu-tive compensation typically revolve around: how much senior managers should get paid; how that pay should be linked to performance; and the impact of pay on the risks that senior managers are prepared to take.

It is not easy to determine before the fact the optimal level of executive pay, beyond re-sorting to generalized considerations such as appropriateness and level of competitiveness in the top talent markets.

Viewed in retrospect, there are legitimate concerns about executive pay related to: its weak relationship with profitability or per-formance; the ever widening gap between top executive pay packages and average salaries in developed economies; and the growing ac-knowledgement that most remuneration sys-tems tend to incentivize decisions and actions that favor short-term results.

In response, the governance provision of say-on-pay invites shareholders to weigh in on the compensation being offered to top man-agers and board members, with remuneration policies and golden parachute arrangements

shareholders

Beyond the Balance sheet

IN ADDITION TO CLEAR FINANCIAL STATEMENTS,

TRANSPARENCY IMPLIES MORE FLUID

COMMUNICATION AT THREE LEVELS.

EXHIBIT 1

Producing a risk evaluation reportProviding information about

the companys future prospectsclarifying who is taking what decisions

based on which criteria

society

Publishing social and environmental impact reports Explicit communication about how the company

intends to manage the business risks it faces Open and honest information about how supply chains

are managed, particularly with regard to working conditions and labor practices involving external suppliers

board of directors

Specialized committees for studying strategic issues A better balance of power between the cEO

and chair roles A bigger role and remit for non-executive advisers Shared responsibility for cEO hiring, evaluations and

succession planning

ManageMent


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having to be disclosed prior to their imple-mentation.

This transparency rule has become a source of much debate, with no clear consensus on whether this provision is a help or a hindrance, nor is there a harmonized approach to this issue across jurisdictions.

The European Commission recently pro-posed an E.U.-wide directive to introduce say-on-pay for the 10,000 companies listed on Europes stock exchanges. According to a state-ment by the European Commission, the new measure would oblige companies to disclose clear, comparable and comprehensive informa-tion on their remuneration policies and how they were put into practice. There would be no binding cap on remuneration at E.U. level but each company would have to put its remunera-tion policy to a binding shareholder vote. The policy would need to include a maximum level for executive pay. It would also need to explain how it contributes to the long-term interests and sustainability of the company. It would also need to explain how the pay and employ-ment conditions of employees of the company were taken into account when setting the policy including explaining the ratio between average employees and executive pay.

Switzerland tried to tackle the issue of com-pensation with a regulation that would have limited executive pay to 12 times that of the lowest paid, but the proposal was defeated by referendum.

ConFLiCts BetWeen the shoRt teRM & the Long teRM. The final area of conflict arises when a company has too many short-term inves-tors and/or uncommitted senior executives. The inevitable result is an excessive focus on short-term goals, often at the expense of the companys long-term interests.

Yet how this short-term focus translates into policy is not so straightforward. At the in-vestor level, it can lead to a single-minded focus

on quarterly performance, share price volatility and high turnover among fickle investors.

There does not appear to be any easy way of changing this dynamic between shareholders and the companies in which they are invested other than by perhaps giving long-term fund holders a greater voice in corporate gover-nance affairs.

More measures exist to help prevent an excessive short-term focus among manag-ers. Some companies are stacking executive compensation to include a larger element of deferred compensation linked to pension schemes, for example, which only pay off in the long term, rather than allowing too many quick cash grabs in the form of yearly bonuses. Others have introduced clawback clauses, en-abling compensation benefits to be taken back in the event of underwhelming performance by senior managers.

The Financial Stability Board, the body that coordinates the work of national finan-cial authorities at

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