Home   >  Firm Overview  >  Harshbarger Governance Practice THE NEW REALITIES OF CORPORATE GOVERNANCE By Scott Harshbarger While many of the governance issues that organizations face are not new, the environment in which they confront them is more challenging than ever. The responses to the spectacular collapses of Enron and WorldCom were immediate, systemic, and widespread and have only continued to gain strength with the passage of time. The string of governance failings from Boston University to Enron, and from Putnam to the New York Stock Exchange, serve to illustrate a core lesson of the new realities of corporate governance: no entity is immune to the changed environment. How has the environment changed? State and federal law enforcement have applied significantly increased resources and a more aggressive philosophy toward confronting governance lapses. The media spotlight has increased awareness among those constituents directly affected as well as the business community as a whole. The spotlight burns brighter than ever as constituents begin to ask more pointed questions and work to develop standards of their own. Shareholder proposals are taken more seriously, the NYSE, NASDAQ, and the FDIC have all promulgated new standards, and the Corporate Library and Business Roundtable continue to challenge for even better standards. Even the judiciary, in the most recent Disney case, has demonstrated its willingness to reopen VanGorkum through a more stringent definition of good faith. And finally, adding to the volatility, public corporations are now expected to be in compliance with Sarbanes-Oxley, legislation that has left many unanswered questions as to where the hard lines will be drawn. Navigating the new governance terrain While we are likely to see periods of relative certainty and predictability in the governing standards, it is unlikely that they will ever completely level off. The environment will always, at least to some degree, be changing. The important point then is to recognize the shifting landscape, and work to stay out in front of the shift, so that your organization is not caught by altered expectations. While nothing that either Richard Grasso or his board at the New York Stock Exchange did was explicitly illegal, everyone involved was clearly tone deaf to the shifting environment and were forced to pay a heavy price. Successfully navigating the new realities of corporate governance thus requires not only an in-depth understanding of the entity itself, but also an in-depth understanding of the new environment in which every entity now operates. It requires understanding the 360o response that has taken place. Here are a few relatively simple steps to take that will help keep your organization ahead of the curve: Maintain tone sensitivity to the shifting environment It is critical to have independent monitor with a global perspective. By global perspective, I mean an independent body that understands the regulatory environment and enforcement efforts, as well as there impact across multiple sectors Adapt efficiently and appropriately Stay out in front of the curve by complying with the spirit of new regulations, standards, and expectations, not just the letter. Communicate the standards under which your organization operates Internally and externally communicating the organization’s standards helps both to build an ethical organization and to create the perception of an ethical organization, which keeps inquiries to a minimum. Build cordial and professional relationships with regulators Manage the entity’s relationship with regulators rather than waiting to be managed by the regulator As the new realities of corporate governance set in, the substance of the new laws and rules must not be lost in the race to comply with their form. In the early stages of the governance reforms, the easiest thing to do is to proceed down the requirements of the laws and rules, and check the box next to each requirement the organization meets. The problem with this approach is that it emphasizes form over substance, making implementation of the new regulations a costly endeavor with little or no real benefit. In order to derive any benefit from implementing the new regulations, organizations must make a good faith effort to comply not just with the letter of the law, but with the spirit of the new reforms too. In making a good faith effort to comply with the spirit of the new reforms, organizations recognize three primary benefits. First, a good faith effort to comply with the spirit of the new regulations provides organizations with a stronger measure of insurance. One of the first things an investigator will look for in an organization is whether or not a good faith effort was made to comply with both the letter and the spirit of the regulations. A good faith effort is a strong mitigating factor in any sanctions imposed. Second, in going beyond the letter of the law and crafting a systematically and systemically self-critical organizational culture, more accurate information flows to the top, enabling more efficient and effective business decisions. Lastly, the imprecise reforms offer business leaders the opportunity to emerge with more well defined standards and thereby seal off additional regulation. Complying with the spirit of Sarbanes-Oxley and the new environment is as much an ethical challenge as it is a legal challenge. Successful implementation requires an understanding of not only the specific legal requirements, but also the broader environment in which all organizations now operate. The lesson from the failings at the NYSE is that no leader in any sector, regardless of whether or not Sarbanes-Oxley directly applies to the organization, can afford to be tone deaf. Leaders must recognize that they operate in a constantly changing environment, and they must make concerted efforts to maintain a high degree of sensitivity to an evolving climate. Organizations must, therefore, be nimble enough to respond efficiently and effectively with any necessary changes. In order to be well positioned in a continually evolving environment, organizations need an independent monitor capable of understanding the myriad forces combining to shift both expectations and requirements. The shape the Sarbanes-Oxley reforms take will be as much dictated by the law itself, as it will be by judicial interpretation, media and investor scrutiny and perhaps, most importantly, the business community’s response. Given the number of factors at work, the uncertainty surrounding the direction the reforms are likely to take is entirely understandable. The important point for leaders to recognize is that they must keep a finger on the pulse of the shifting environment and adapt accordingly. Standards may plateau periodically, but over time they will continue to evolve. Boards must reach out to find ways to continue to infuse independent and fresh perspective. Reaching out for independence does not mean reaching out for ignorance Adding independence to boards should not come at the expense of adding ignorance to the board. Independent directors are expected to have the same depth and breadth of expertise in such areas as finance, human resources, ethics, legal, technical, sales, etc. as their non-independent colleagues. The difference is that the independent members bring their expertise from outside sources – experience in other organizations, sectors, industries, etc. They rely on the same analytical skills the inside directors have developed through the course of growing and developing their business, but they are unencumbered by the view from the inside. The value that independent directors add is in the fresh perspectives they offer. And a fresh perspective enables organizations to maintain a high degree of tone sensitivity to the rapidly shifting governance environment. A strong independent board will keep an organization one step ahead of the curve. As boards become increasingly independent, the role of the inside directors becomes even more critical to the success of the organization. The role of management and the inside directors is to be experts within the organization. It becomes even more critical that they do their homework and prepare well for every meeting. The independent board must be educated on the practices of the organization, the particular business and industry challenges the organization faces, and the strategic direction of the corporation. An independent director can only be successful if she can apply her analytical skills and background and experiences to a specific set of facts within the organization. Management and inside directors need to make sure that the independent directors get the education and training they need to effectively evaluate the practices, procedures and strategy of the organization. The role of a director has never been to manage the corporation. The role of the director is to provide oversight. The more independent the overseeing body is, the more easily the organization can craft the systematically and systemically self-critical culture which I have already mentioned. If the oversight function at the top is not both perceived as independent and in fact independent, then the upward flow of information is likely to trickle at best. The weakening of the upward flow of material information has a dual effect. First, it trains those at the lower levels to be less self-critical and less critical of the organization. Second, without the up-flow of information, management and the board cannot know the impact of their policies, procedures and practices. As a result, an organization without a steady upward flow of information is unable to respond efficiently and effectively. The business community has a real opportunity right now to work to define new standards and seal off additional regulation as a viable response. Sarbanes-Oxley and the new environment in which organizations must operate are powerful levers enabling those on the inside to make the case for change. Having an effective governance system is not only the right thing to do, it is the only thing to do in this new environment. First, a sound governance system provides an inexpensive insurance mechanism to the organization. Second, demonstrating a commitment to getting out in front of the curve, and publishing the governance standards by which the organization operates, acts to pre-empt one-size-fits-all regulation. Finally, having an effective governance system in place enables the organization to meet the heightened expectations of investors and other stakeholders. Rather than focusing energy and resources on resisting the wave of changes, leaders should be embracing this period of reform as an opportunity to institutionalize the systems under which the vast majority of organizations have already been operating. Business leaders have a real opportunity to use this period of scrutiny in an uncertain environment to define the standards by which they will be governed. But, in order for that to happen, business leaders need to formalize the systems they have in place and communicate the standards under which they operate. The investment of time and resources in developing those standards is insignificant compared to the cost of additional regulation or a damaged reputation. Moreover, for most organizations this is nothing new. It is simply a matter of bringing greater formality and more effective communication to bear in relation to existing governance practices.