Governance Instruments – Principles of Corporate Governance

The first step in establishing a portfolio of internal governance instruments is the preparation, approval and implementation of foundation principles of corporate governance as determined by the board of directors in line with the requirements of statutes, regulatory guidance and, in the case of public companies, listing guidelines.  Regardless of whether the board has adopted formal corporate governance principles, directors, when discharging their duties as a director, are expected to act in good faith and in a manner the director reasonably believes to be in the best interests of the corporation.  In addition, board members, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, must discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances (i.e., the so-called “duty of care”).  Corporate governance principles are designed to lay out a series of basic rules that the entire board, as well as individual directors, can refer to as a guide for fulfilling their fiduciary duties.
This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
Corporate governance principles should be drafted to conform to the corporate law of the state in which the corporation is incorporated and organized, since this is the primary source of the law relating to the duties and rights of corporate directors and officers.  Even public companies need to abide by state law regulations relating to such things as number of directors; qualifications of directors; election of directors; terms of directors; shareholders’ rights to remove directors; and directors’ meetings and actions.  A number of states, notably California, Delaware and New York, have periodically amended their corporation laws to accommodate the changing needs of public companies that are incorporated in their states. For example, state laws now accommodate the common practice of staggered terms for directors and have continuously updated their rules and regulations relating to indemnification of directors and officers.  In addition, state law is the primary source of the essential duties of directors and officers to the corporation and its shareholders, notably the duty of care and duty of loyalty in the course of discharging their obligations. In fact, the reporting obligations imposed under revisions to federal law specifically refer to potential violations of fiduciary duty by directors and officers, as well as violations of federal securities laws.  In addition to their duties and potential liabilities under state corporation laws, corporate directors and officers of public companies are subject to substantial potential liabilities for violations of federal securities laws. Among the areas of greatest concern is the possibility of liability for violations of insider trading rules and restrictions and for misrepresentations in registration statements filed under the Securities Act of 1933, as amended.
Most of the available examples of corporate governance principles are based on the requirements imposed on public companies under the Exchange Act and the listing standards and requirements of the NYSE and the Nasdaq; however, even for smaller companies that are not subject to the requirements of the Exchange Act and the major securities exchanges, the listing guidelines provide a good template to follow for creating comprehensive corporate governance principles.  NYSE Listing Manual § 303A.08 requires that NYSE listed companies adopt and disclose corporate governance guidelines addressing the following subjects:

• Director qualification standards. These standards should, at minimum, reflect the independence requirements set forth in NYSE Listing Manual §§ 303A.01 and 303A.02. Companies may also address other substantive qualification requirements, including policies limiting the number of other directorships a director may accept, and director tenure, retirement and succession.
• Director responsibilities. These responsibilities should clearly articulate what is expected from a director, including basic duties and responsibilities with respect to attendance at board meetings and advance review of meeting materials.
• Director access. Director access to management and, as necessary and appropriate, independent advisers.
• Director compensation. Director compensation guidelines should include general principles for determining the form and amount of director compensation (and for reviewing those principles, as appropriate). The board should be aware that questions as to directors’ independence may be raised when directors’ fees and emoluments exceed what is customary. Similar concerns may be raised when the listed company makes substantial charitable contributions to organizations in which a director is affiliated, or enters into consulting contracts with (or provides other indirect forms of compensation to) a director. The board should critically evaluate each of these matters when determining the form and amount of director compensation, and the independence of a director.
• Director orientation and continuing education.
• Management succession. Succession planning should include policies and principles for CEO selection and performance review, as well as policies regarding succession in the event of an emergency or the retirement of the CEO.
• Annual performance evaluation of the board. The board should conduct a self-evaluation at least annually to determine whether it and its committees are functioning effectively.

In order for listed companies to comply with many of the requirements in the NYSE corporate governance standards, they are required to have and maintain a publicly accessible website.  The Commentary to NYSE Listing Manual § 303A.08 requires that each listed company’s website must include its corporate governance guidelines, code of business conduct and ethics (discussed below) and the charters of its most important committees (including at least the audit, and if applicable, compensation and nominating committees).  In addition, the listed company must state in its annual proxy statement or, if the company does not file an annual proxy statement, in the company’s annual report on Form 10-K filed with the SEC that the foregoing information is available on its website, and that the information is available in print to any shareholder who requests it.
Nasdaq does not have specific requirements with respect to content and adoption of corporate governance guidelines; however, it should be expected that companies subject to Nasdaq listing standards should adopt guidelines on a voluntary basis that address all of the categories of corporate governance regulated by Nasdaq including distribution of annual or interim reports, independent directors, audit and compensation committees, nomination of directors, code of conduct, annual meetings, solicitation of proxies, quorum, conflicts of interest, shareholder approvals and voting rights.
Obviously companies should take into account any specific laws, regulations and listing standards when drafting their corporate governance guidelines and the format for presenting the information will vary depending on the preferences of the drafting group.  In general, however, the following topics should be covered:

• Composition and Organization of Board of Directors: Size of the board; membership qualifications; selection procedures; independence requirements; term limits; retirement age; changes in professional responsibilities; and guidelines for selection of the chairperson of the board.
• Duties and Responsibilities of Directors: Adoption of procedures for review of contracts and allocation of signature authority with respect to company contracts; guidelines for the regular assessment of the performance of the board of directors; procedures for evaluation of the performance of the CEO and other members of the senior management team; procedures for succession planning and leadership development; procedures for director involvement in the formulation and evaluation of the company’s strategic and operating plans; conditions and procedures relating to interaction of board members with investors, the media and company business partners; and plans for director development including new director orientation and continuing director education.
• Director Compensation and Related Party Transactions: Establishment of compensation policies for directors; procedures for setting compensation, including participation by the nominating and corporate governance committee of the board; requirements as to minimum stock ownership; and procedures for preventing conflicts of interest and approving related party transactions.
• Meetings and Committees of the Board of Directors: Preparation and attendance; frequency and length of meetings; meeting agenda; distribution of meeting materials; executive sessions; attendance of non-directors at meetings; director access to senior management and other information regarding the company and its business activities; director access to independent advisers; number of committees; assignment of board members to committees; committee charters and authority; committee agendas; frequency and length of committee meetings; and executive sessions.

A useful and impressive resource, albeit somewhat dated, for understanding the topics that should be addressed in corporate governance guidelines was a survey and comparison prepared in 2005 by the law firm Weil, Gotshal & Manges LLP that included recommendations from the then-current versions of reports published by the American Law Institute, The Business Roundtable, the National Association of Corporate Directors, The Conference Board Commission on Public Trust and Private Enterprise, the California Public Employees’ Retirement System, the Council of Institutional Investors, the Teachers Insurance and Annuity Association–College Retirement Equities Fund, the American Federation of Labor and Congress of Industrial Organizations, the Organization for Economic Cooperation and Development and the Business Sector Advisory Group on Corporate Governance (see Comparison of Corporate Governance Guidelines and Codes of Best Practice (Weil, Gotshal & Manges LLP, 2005)).  The survey also included Corporate Governance Guidelines adopted by the board of General Motors, the version of which that was in effect in 2017 covered the following topics:

• Board Mission and Responsibilities
• Selection and Composition of the Board: Board Designation Rights under Stockholders Agreement; Board Membership Criteria; Board Membership Selection and Nomination; Majority Voting in Board Elections; and Director Orientation and Continuing Education
• Board Functioning: Selection of the Chairman of the Board and Role of Lead Director; Size of the Board; Mix of Management and Independent Directors; Board Definition of What Constitutes Independence for Directors; Former Chief Executive Officer Board Membership; Directors Who Change Their Present Job Responsibility; Limits on Outside Board Memberships; Meeting Attendance; Retirement Age and Term Limits; Board Compensation; Stock Ownership of Non-Employee Directors; Executive Sessions of Non-Management Directors; Access to Outside Advisers; Assessing the Board’s Performance; Ethics and Conflicts of Interest; Confidentiality; Board Interaction with Shareholders and Other Interested Parties
• Board Relationship to Senior Management: Regular Attendance of Non-Directors at Board Meetings; and Board Access to Senior Management
• Meeting Procedures: Selection of Agenda Items for Board Meetings; and Board Materials Distributed in Advance
• Committee Matters: Board Committees; Committee Performance Evaluation; and Assignment and Rotation of Committee Members
• Leadership Development: Formal Evaluation of the Chief Executive Officer; Succession Planning; and Management Development

Corporate governance principles should be treated as continuously evolving and provision should be made for review and, if necessary, modification of the principles no less frequently than annually, preferably in advance of the company’s annual meeting of stockholders and preparation and distribution of corporate governance reports.  For example, many companies have amended their corporate governance principles to include procedures for ensuring that stockholders and other stakeholders have adequate access to individual board members.
By the way, the Weil Gotshal report, as well General Motors’ Corporate Governance Guidelines and other examples of corporate governance principles and additional commentaries on preparation of such principles, can be found as part of “Governance Codes and Policies” in the management tools available as part of “Governance: A Library of Resources for Sustainable Entrepreneurs” prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org).
This article is adapted from material in Sustainability and Corporate Governance: A Handbook for Sustainable Entrepreneurs, which is prepared and distributed by the Sustainable Entrepreneurship Project and can be downloaded here.
Alan Gutterman is the Founding Director of the Sustainable Entrepreneurship Project, which engages in and promotes research, education and training activities relating to entrepreneurial ventures launched with the aspiration to create sustainable enterprises that achieve significant growth in scale and value creation through the development of innovative products or services which form the basis for a successful international business.  Visit the Project’s Library of Resources for Sustainable Entrepreneurs to download handbooks, guides, articles and other materials relating to sustainable entrepreneurship and keep up with the Project’s activities by following Alan on LinkedIn, Twitter and Facebook.