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American Corporate Governance Index

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American Corporate Governance Index american corporate governance index Making Strides Amid Crisis TABLE of CONTENTS Introduction.......................................................................................3 Corporate Governance in 2020 ..................................................... 4 Understanding the grade .............................................................. 5 Key Observations ............................................................................. 6 Incremental improvement across all principles, but trouble spots remain .............................................................. 6 Boards still don’t challenge management .................................. 6 Regulation and size matter during crises ................................... 6 Management structure, CAE reporting lines correlate to stronger governance .................................................................7 Lowest scoring principles continue to lag .................................. 9 COVID-19’s Impact .........................................................................11 Corporate Governance Roles ....................................................... 12 Three Lines Model ..........................................................................13 Defining the Guiding Principles .................................................. 14 Guiding Principles of Corporate Governance .......................... 16 Additional Findings ....................................................................... 25 Guiding Principles ......................................................................... 29 Demographics .................................................................................31 Index Methodology ....................................................................... 32 Acknowledgments ......................................................................... 34 Introduction Organizations globally were tested in 2020 like never before. The COVID-19 pandemic created a firestorm in virtually every aspect of business, from cash flow challenges prompted by extended lock downs, to extraordinary customer and employee safety measures, to talent management and technology issues created by distributed workforces. These trials of organizational resilience and crisis management were spread across all sectors and industries, creating varied and unique challenges. Yet, at least for publicly traded organizations responding to this year’s American Corporate Governance Index (ACGI) survey, the health of the nation’s corporate governance not only held its own, it improved slightly during the greatest global public health crisis in a century. Data gleaned from this year’s survey of chief audit executives (CAEs) finds modest but consistent improvements across all of the index’s eight Guiding Principles. However, boards continue to earn low marks on challenging management assertions and verifying information received from the C-suite. Compared to last year’s results, company size (revenues) and industry took on a bigger role in explaining variation in ACGI scores for 2020. The results suggest that during periods of heightened risk, like during 2020, companies in regulated industries (financial services, and transportation and utilities) have stronger governance, regardless of company size. In contrast, we see a greater separation in governance scores between smaller and larger companies when companies operate in unregulated industries, where bigger is more likely to be better. The pandemic-fueled focus on crisis management, updated risk assessments, and stronger alignment among risk management players may have contributed to the stronger showing on overall governance. However, as COVID-19 stretches into a second calendar year and new surges of the deadly virus grip regions around the United States and the world, it will be important to monitor the longer-term implications of its disruptive influence on corporate governance. 3 Corporate Governance in 2020 B-- 82 Corporate governance is never more important than during a crisis. This was reflected in CAE assessments of their companies’ 2020 corporate governance performance, with overall assessments notching slightly higher than pre-pandemic index scores. The 2020 ACGI score for corporate governance health in the U.S. is a B- (82), on average, an improvement from last year’s overall score of C+ (79). There continues to be significant variations in the overall assessment of corporate governance effectiveness across organizations (Figure 1). The most notable improvement is the decrease in companies reporting a failing governance grade. In 2019, 10% of surveyed companies received an F, compared to only 2% in 2020. Similar to last year, the majority of companies score in the B and C range of governance performance, with less than one-fifth of companies earning an A-range performance. FIGURE 1: DISTRIBUTION OF ACGI SCORES BY LETTER GRADE (n=131 IN 2020; N = 128 IN 2019) 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% A+ A A- B+ B B- C+ C C- D F 2019 2020 4 Understanding the grade The ACGI and its Guiding Principles are designed to foster the highest level of corporate governance, which should be the aspirational goal of every organization. Any rating less than the highest standard, an A+, reflects room for improvement. This year’s three-point increase nudges the final overall score from a high C to a low B. This progress may reflect improved governance practices relating to business responses to the COVID-19 crisis. The Guiding Principles are based on a compendium of relevant guidance and principles advanced by experts in the field, including the National Association of Corporate Directors (NACD), the New York Stock Exchange, the Committee of Sponsoring Organizations of the Treadway Commission (COSO), the Business Roundtable, the Investor Stewardship Group, the University of Tennessee’s Neel Corporate Governance Center, The Institute of Internal Auditors (IIA), and others. The index gauges the extent to which companies are effectively achieving each of the Guiding Principles. The ACGI goes beyond the publicly observable aspects of corporate governance to provide an internal perspective on the effectiveness of corporate governance throughout the organization. In forming the survey questions that support the ACGI, it is assumed that corporate governance does not allow for a one-size-fits-all approach and that companies will need to find their own best practices based on various factors, including company age, size, complexity, and extent of international operations. 82 79 5 Key Observations INCREMENTAL IMPROVEMENT ACROSS ALL PRINCIPLES, BUT TROUBLE SPOTS REMAIN Scores across the eight Guiding Principles show small and consistent gains with no one principle improving by more than five points on a 100-point scale. The biggest gains were seen in meeting shareholder/stakeholder expectations (Principle 2) and board performance (Principle 3). However, the smallest gains were seen in areas of greatest concern from 2019. Information given to the board (Principle 6) saw a one-point increase year over year to 79, while evaluating corporate governance (Principle 8) had a moderate three-point gain but still rated a disappointing 75. Within the lower-performing principles, the least effective elements continue to be: the extent to which board members ask whether the information presented to the board is accurate and complete, and the board’s protection of proprietary information. These elements remain the lowest scoring of all and the only ones that rate under 70. BOARDS STILL DON’T CHALLENGE MANAGEMENT As in 2019, the 2020 ACGI survey finds that more than one-third of board members are not willing to offer contrary opinions or push back against the CEO. Principle 3, which focuses on board performance, otherwise saw gains across elements addressing the board’s technical expertise, diversity of perspectives, pushing for sufficient details, time to properly execute its role, appropriate compensation, self-evaluation, and follow through on improving weaknesses. Yet, the board’s willingness to challenge management remains low, bumping up a single point to 76 out of 100. REGULATION AND SIZE MATTER DURING CRISES Regulated companies tended to earn higher grades, and among unregulated companies, larger companies have stronger governance. Responding companies with total revenues of more than $10 billion were significantly more likely to rate as having strong governance or a “high” grade (A+, A, A-, B+) (Figure 2A) and significantly less likely to rate as having weak governance or a “low” grade (C, C-, D, F). Stronger governance by high-revenue companies may be linked to access to greater resources and larger governance structures. Survey data did not find a significant difference in ACGI scores based on the number of years operating as a publicly traded company (Table 2, page 25). However, in contrast to 2019 results, where regulation had little-to-no correlation with ACGI scores, data suggest that regulation matters during a year filled with crises. FIGURE 2A: ACGI SCORES BASED ON COMPANY REVENUE > $10 billion $1 – $10 billion < $1 billion 0% 10% 20% 30% 40% 50% 60% LOW MEDIUM HIGH 6 The size effect observed in Figure 2A is driven by companies operating in unregulated industries (Figure 2B), with size having almost no effect on regulated companies’ governance. Based on open-ended survey question responses, it appears COVID-19 contributed to stronger focus on risk management alignment, which could explain higher governance scores among heavily regulated
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