Moving Governance from Board-Centric to Shareholder-Centric

The Data Management Transformation

With the congressional approval of Dodd-Frank Act of 2010, Data Management departments now have both the responsibility and the opportunity to become one of the most strategically important organizations in public companies. The responsibility to assume the central role in strategy management is far more than what is granted by virtue of the functional duty – it is now mandated by law. Unknown or unclear to many companies, Dodd-Frank Act of 2010 has now elevated the role and responsibility of the Data Management departments to a new level. The opportunity to live up to that standard is the challenge that Data Management departments will have to meet. The bar has been set much higher and it is now up to the Data Management heads to embrace this opportunity or to falter.

Inability to meet the standards goes much beyond incompliance with the requirements of the Dodd-Frank Act. Now, it can impact the executive compensation, lead to dramatic changes in the boards, and give way to significantly more shareholder activism. Getting their act together and improving the processes and performance of the Data Management organizations will result in increasing internal customer satisfaction, greater shareholder approval, and unparallel rise in the power and role of the Data Management heads.

In this paper we will examine the Dodd-Frank Act and the general implications on governance. In the second part, we will demonstrate how these requirements would increase the role, responsibility, and performance requirements of the Data Management departments. .

Part I: Dodd-Frank Act of 2010 and Shareholder-Centric Governance Transition

The 2008 recession of the United States made it clear to the legislative bodies that Sarbanes-Oxley, while important, was not sufficient to guard against a rapid and dangerous rise in systemic risk. The sudden collapse of the financial system, and many large companies, came as a shock to almost everyone. Clearly, there were holes that were not addressed by the previous regulations, and the need for additional legislations became apparent. The Dodd-Frank Act was passed to improve the management of the systemic risk in order to avoid sudden shocks to the economy in the future.

While a significant part of the legislation deals with the financial institutions, certain parts of the law apply for all publicly traded companies. The focus of the following discussion will be on those parts of the law that apply to all companies.

The most important element of the Act is designed to create a new balance of power between shareholders, board of directors, and the management teams of companies. Since the creation of the financial markets and the related reporting requirements for publicly traded companies, the dominant model of corporate governance focused on giving powers to the boards and the management teams. Dodd-Frank Act has now given additional and unprecedented powers to shareholders. This is a gigantic change as the shift in power implies greater shareholder involvement in the management of companies. Instead of being at the receiving end of the strategy and often victimized by the strategy related decisions of the management teams and boards, shareholders will now have significant more say in how companies are run. Instead of the traditional board-centric model of governance, companies will now have to shift to a shareholder-centric model. In the next section, we will explain what that model ought to be and how to implement that transition.

The second important element of the Act applies to executive compensation. It will require disclosure of the relationship between executive compensation and financial performance. SEC is being directed to promulgate rules that will require issuers to demonstrate the link between the compensation paid to the executives and the company’s financial performance as measured from the stock performance of the company and arguably the total returns to the shareholders. Voting on compensation, At least once in each six year period, shareholders will vote in a non-bonding vote to approve the compensation of executive officers as disclosed in the proxy statements. Such votes can take place on a one year, two years, or three years basis.

Companies will also be required to disclose merger or sale of business related compensation or other similar arrangements and shareholders will vote with a separate non-binding vote to approve those compensations.

The investment firms that have investment discretion of $100 million or more of equity in US public companies would be required to disclose how they voted in the above “say-on-pay” regulations.

The Act also requires national security exchanges to ensure compensation committee members to be “independent” of the issuer. Similar requirements exist for the independence of Committee Advisors. The focus is on making sure that there is no conflict-of-interest for the consultants and advisors who provide advice on executive compensation.

The third important element of the Act gives shareholders the power to nominate new board members via proxy. Shareholders will be able to include their own nominees for election to the board of directors in a company’s proxy statements and proxy card.

The likely outcome of this regulation would be 1) More competition for annual director

The Dodd-Frank Act has changed the governance model from Board-centric to Shareholder-centric by giving shareholders significantly more rights.

elections. 2) Greater potential for involvement of activist shareholders and funds. 3) Greater scrutiny for executive compensation and company performance.

These above requirements of the Act will have a tremendous impact on how companies are managed, how their strategies are developed and how their operating plans are implemented. While the casual review of the Act requires companies to establish a link between the company performance and the executive compensation, its implications are enormous. We believe that implementing the above requirements would require an overhaul of the entire strategic and operating planning process of companies.

Shareholder-Centric Governance

Requiring companies to transition to shareholder-centric governance model and tying executive compensation to the financial performance are not inconsequential changes. Consider the following situations:

  • Management teams often pursue strategies for the long-term while ignoring the short term performance. From their perspective, they are doing what is in the best interest of the company in the long run, however the stock takes a hit in the short term and by the time the long term strategies are expected to show results, capital has already shifted to other, more attractive, opportunities. In many cases, too much focus on long term at the cost of short term can make it harder for companies to continue to keep investors excited about the future prospects. How can management establish a balance between short term and long term value?
  • Management teams sometimes pursue short term strategies at the cost of long term value and shareholders respond appropriately. If too much focus is kept on the short term profitability at the cost of long term, shareholders can see through it and stock can get hammered. Again how would a company establish a balance between short-term and long-term?
  • Management teams sometimes have to make decisions that may appear as hurting the shareholder interests, but given the circumstances choosing the next best alternative would have been worse for the shareholders. How can management teams communicate such decisions so that shareholders don’t penalize the stock unnecessarily?
  • New opportunities can arise due to sudden changes in market structures and management may have to shift the stated strategy of the company which, if not explained to the satisfaction of the shareholders, can make investors very nervous. How can company communicate major strategy changes?
  • Company strategies are sometimes driven by subjectivity and emotional judgments. Such strategies can be dangerous for the long-term viability of the company. In many cases, analysts and shareholders can provide early guidance to the company and can alter the management behavior. How can companies measure and communicate such strategies internally?
  • Management teams sometimes have to take risks that go above and beyond what shareholders expect and these risks can sometimesshift the risk-reward balance of the overall portfolio.These risks can be perceived or real. How can companies track the risks taken and report them to shareholders in a way that explains the logic behind decisions?

Since there are a number of factors that can influence the stock price, it is important to keep track of the environment, strategies, and performance in a dynamic environment. The five key themes from the above discussion are as follows:

  1. Shareholder expectations are a source of guidance in strategy making and they should be seriously considered when making important decisions.
  2. Explanations to decision-making should be developed as empirically as possible to alleviate the allegations of management bias. This may include the rationale behind making an apparent sub-optimal choice because the second best choice would have been worse.
  3. Strategies should be developed in accordance with their ability to create financial value for the company and have a positive stock impact.
  4. Shareholder engagement on its own merit is now even more important – however engagement must now be empirically measured, recorded, reported, and communicated.
  5. Risk taking – which is at the core of business should be done in a responsible manner. Obviously, every business has a right to take risks (no risk, no return), however it is important that shareholders are informed about those risks and full transparency is established.
  6. Economic value creation and the traditional value drivers such as revenues, earnings, or return on invested capital don’t necessarily drive the stock value.

Part II: Shareholder-Centric Governance: Capability Enhancement for Data Management Departments

Knowing: Ignorance cannot be used as an excuse anymore. Data Management departments are required to develop and maintain a state of high awareness. The awareness must include active and timely knowledge of both internal and external value drivers. Company strategies, plans, and operating logic should be clearly understood – as well as the shareholder viewpoint, expectations, and market drivers.

Recording:Data Management departments would have to develop capabilities to record several events, inputs, comments, concerns, and viewpoints that are not tracked today. Recording information will help in managing internal processes of the department and provide the necessary audit trail necessary to address shareholder concerns, board inquiries, and executive compensation justification.

Engaging: Data Management would be expected to engage all stakeholders on a proactive basis.

Measuring:Recording information helps but to get maximum value out of it, Data Management departments would need to deploy measurement standards and content that can enable rapid analytical capability. While Data Management departments tend to get the gist or essence of strategies, market sentiment, and shareholder expectations, they will now need an empirical and data based system to measure both internal and external drivers of shareholder value.

Relating: The information acquired from the outside sources such as shareholders and analysts should be reported internally in such a manner that it has actionable impact on the strategies pursued by the company and the management behavior. The analytical capabilities acquired through Knowing, Recording, and Measuring would require a dynamic link with actual goals, strategies, plans, and operating initiatives. Bridging the gap between shareholder expectations and your firm’s value would be critical.

Communicating: In the modern Data Management organizations, Communicating would become a dynamic and powerful two-way communication channel. As a conduit between shareholders and the management teams, the excellence in Data Management would be realized through active, accurate, reliable, credible, relevant, and action worthy information exchange between the two worlds. Companies would have to rely on information acquired from shareholders, just as shareholders depend on information provided by companies. All communications given out by a company – for example disclosures, presentations, press releases, statements – would need to be tracked and captured in a meaningful way.

Institutionalization:The process of data collection, measuring, and reporting means nothing if the core processes of Data Management are not institutionalized across the company. Institutionalization implies connecting the core Data Management processes with other value creation processes in a company.

Organizational Change Management:These processes and the required compliance would be new for many Data Management departments but the shift from board-centric model to shareholder-centric model would be foreign for other internal organizations. Data Management departments would need to inform the internal organizations about the shareholder expectations and to configure strategic plans in accordance with that.

Verification: Having data and information integrity would be key to managing future Data Management departments.

Improving: The last dimension is self reflection, introspection, and never-ending performance improvement of the Data Management departments.