Boards have addressed many of the most glaring governance shortcomings by nominating a majority of independent directors, holding annual director elections and supporting directors as they engage directly with shareholders.
Now shareholders want to know how directors are overseeing risk.
“Shareholders are definitely asking,” said Ken Bertsch, executive director of the Council of Institutional Investors, and boards should be prepared to demonstrate that major risk categories are on their dashboards and being properly monitored.
The pervasiveness of risk in everyday business means that boards must look at risk as an integral part of strategy.
“Boards increasingly must address the full range of risks and opportunities relevant to their strategy and value creation,” said Zach Oleksiuk, CFA, head of BlackRock’s Corporate Governance and Responsible Investment team.
Oleksiuk fully acknowledges that management has the responsibility for setting strategy, but in partnership with the board: “The board has an oversight role but works with management to ensure that the strategy is appropriate for the company and is well articulated to the market.”
“We expect companies to take risk—that’s how they make money over time,” he added. “But the board needs to ensure that the strategy is in line with the firm’s determined risk appetite.”
Anne Sheehan, head of corporate governance for CalSTRS, noted that the board plays an important role in the current environment of low returns for shareholders. “The board provides oversight not only for strategy and risk but also for what the company is doing with its capital.”
But the concept of what constitutes risk has broadened significantly in recent years and now goes well beyond strategic and financial considerations to include environmental risk, reputational risk and others depending on industry, geography and additional factors.
Rakhi Kumar, managing director, head of corporate governance at State Street Global Advisors (SSGA), notes that boards should regard climate change as they would any other significant risk to the business. It is important that boards ensure that a company’s assets and its long-term business strategy are resistant to the impacts of climate change.
“We focus on the kinds of risk that impact long-term value,” said Kumar. “Climate risks would naturally fall into the category of low probability, but the impact on the environment would be high.”
SSGA also sees reputational risks in C-suite pay. “We have developed and published frameworks on key topics of what we are looking for and what raises concerns for us,” said Kumar. “The overall trend of increasing CEO pay despite poor stock performance is definitely of concern to investors.”
In response to directors who told SSGA that they are better at highlighting problems than about suggesting solutions, State Street Global Advisors issued three papers: one on reputation risk in C-suite pay, another on climate change risk oversight and a third on board leadership.
“These papers provide high-level but clear expectations of how we evaluate these issues,” said Kumar. “The directors have said they appreciate the papers, and as governance is evolving we believe there should be wider debate on these issues.”
“One aspect of risk oversight that has not been commented on enough is that investors, including the governance teams, have a better sense of how boards work than they did. Which should be good for everyone,” said Bertsch.