Amidst another season of corporate scandals, it's not surprising that U.S. companies are getting low grades on their governance report cards. A new index gives U.S. publicly listed companies an overall grade of C+, with 1 in 10 companies surveyed earning an F for corporate governance.
The IIA and the University of Tennessee's Neel Corporate Governance Center in Knoxville unveiled the American Corporate Governance Index (ACGI) this week at press events in New York and Washington, D.C., where speakers discussed the problems it identifies and how internal audit could help companies address them. Based on an anonymous survey of chief audit executives (CAEs), the index grades companies around eight of the Guiding Principles of Corporate Governance (see "The Making of the Index" below), also released this week.
Beyond the Boardroom
Although responsibility for corporate governance begins in the boardroom, "governance is so much bigger than what's going on at the board level," said Terry Neal, director of the Neel Corporate Governance Center, at the Washington event. This is where internal audit, with its enterprisewide perspective, could help companies improve their grades, he said.
Take the issue of board performance assessments, for example. Principle 8 calls for boards to regularly evaluate "the full system" of corporate governance, yet responding companies received a C- grade — the overall worst grade — with most saying their company didn't formally monitor governance. One takeaway from interviews with CAEs in preparation for the survey is "a lot of CAEs are not doing this, but they are positioned to do it," Neal said.
But the index indicates that boards have problems of their own. Next to assessing corporate governance, the lowest grade (C) was for Principle 4, where CAEs said organizations were more focused on short-term issues rather than sustainable performance. Contributing to short-term thinking, CAEs say one-third of directors would not challenge the opinions of the CEO, and they gave boards a D grade for questioning whether they were receiving accurate and complete information from management.
Board Care and Maintenance
Christa Steele, a former CEO who serves on several boards, said good dialogue between directors and the CEO is key to a well-functioning board. "If directors are not talking to the CEO in board meetings, they should have those conversations offline," she said in Washington.
Steele noted it is difficult for boards to capture all the information about technology innovations, new market entrants, and other disruptive risks in what she calls "unprecedented times." Ahead of board meetings, she said she received a staggering 500 to 1,000 pages of information. "Now more than ever, we need to look at the information and scrub it to make sure we get the right information," she said. "But you can have information overload."
Understanding new risks is one reason "why board refreshment is so important now," she said, because boards often lack the knowledge to provide oversight in an era of greater transparency caused by social media. Although there have been calls for boards to add more specialized expertise — in technology, for example — she says there's a trade-off. "Do you want the technical expert or do you want someone who can ask the right questions?" she asked.
Board members like Steele increasingly want more insight into how the company is governed, even several levels of management down. That's the information that boards aren't seeing, Neal said. It's also where the ACGI finds some disconnects.
Areas of Disconnect
Principle 5 covers corporate culture, and CAEs gave boards and CEOs a high grade (A-) for setting a strong tone at the top. But CAEs say the board doesn't discuss culture much and that tone isn't communicated well across all levels of the company.
Fraud reporting is another example. In an era ripe with corporate scandals, CAEs gave their organizations high marks for following up on reports of wrongdoing and ensuring the company doesn't retaliate against employees who speak up. Yet, CAEs say employees aren't familiar with how to report violations. "When there's an event that occurs, you'll see a spike in reports," said Julie Scammahorn, senior vice president and chief auditor at Wells Fargo in New York.
These disconnects are becoming a greater issue with the rising emphasis on environmental, social, and governance (ESG), an area where companies received a C grade. The ACGI survey was conducted just before the Business Roundtable issued its revised Statement on the Purpose of a Corporation in August, in which prominent U.S. CEOs committed to benefiting stakeholders such as customers, employees, suppliers, and communities, in addition to shareholders.
While internal audit could be positioned to help boards look at risks deeper down in companies, assessing corporate governance is still a new area for many audit functions. Less than one-fourth of companies evaluate corporate governance annually, and when they do, it goes through the legal function, said Lauren Cunningham, assistant professor and director of research at the Neel Corporate Governance Center. "If legal does it, it's a check-the-box mentality," she said.
But more internal audit functions are taking on these assessments, Scammahorn observed. "I'm seeing more auditors taking deep dives into the information the board receives to make sure it is accurate and complete," she said.
Governance audits at the board level should be done by senior audit staff, such as the CAE's direct reports, Scammahorn advised. But they can make a big difference. "If you don't have a formal assessment, there aren't many boards that don't think they're doing a good job," Scammahorn says. "When you put a formal assessment in front of them, they see they have work to do."
The Making of the Index
The IIA and the Neel Corporate Governance Center developed the AGCI based on eight of the Guiding Principles of Corporate Governance. In turn, the two organizations compiled those principles from guidance and principles from organizations such as the Business Roundtable, National Association of Corporate Directors, and New York Stock Exchange.
In preparation for the survey, researchers interviewed prominent CAEs about the principles and their observations of governance practices. They then surveyed 128 CAEs from U.S. companies of various sizes from a wide range of industries. Researchers evaluated these responses and assigned a score and letter grade for each of the principles, as well as elements within those principles. Because responses to the survey were anonymous, the ACGI does not provide grades for individual companies.
Principle 1 — Effective corporate governance requires regular and constructive interaction among key stakeholders, the board, management, internal audit, legal counsel, and external audit and other advisors. Grade: C+
Principle 2 — The board should ensure that key stakeholders are identified and, where appropriate, stakeholder feedback is regularly solicited to evaluate whether corporate policies meet key stakeholders' needs and expectations. Grade: B-
Principle 3 — Board members should act in the best interest of the company and the shareholders while balancing the interests of other key external and internal stakeholders. Grade: B-
Principle 4 — The board should ensure that the company maintains a sustainable strategy focused on long-term performance and value. Grade: C
Principle 5 — The board should ensure that the culture of the company is healthy, regularly monitor and evaluate the company's core culture and values, assess the integrity and ethics of senior management and, as needed, intervene to correct misaligned corporate objectives and culture. Grade: B-
Principle 6 — The board should ensure that structures and practices exist and are well-governed so that it receives timely, complete, relevant, accurate, and reliable information to perform its oversight effectively. Grade: C+
Principle 7 — The board should ensure corporate disclosures are consistently transparent and accurate, and in compliance with legal requirements, regulatory expectations, and ethical norms. Grade: B
Principle 8 — Companies should be purposeful and transparent in choosing and describing their key policies and procedures related to corporate governance to allow key stakeholders an opportunity to evaluate whether the chosen policies and procedures are optimal for the specific company. Grade: C-