Covid-19 Is Rewriting the Rules of Corporate Governance 10/30/20, 1:14 PM Covid-19 Is Rewriting the Rules of Corporate Governance 10/30/20,

rporate Governance 10/30/20, 1:14 PM

Since the onset of Covid-19, corporate boards have faced a string of difficult
decisions. Take the question of dividend payments: Ordinarily, the decision would
CORPORATE GOVERNANCE be a relatively straightforward matter of applying a stated dividend policy,

Covid-19 Is Rewriting the Rules of following past practice, or choosing an amount based on shareholder expectations
and the company’s earnings for the period. But this year, with Covid-19 decimating
Corporate Governance the economy and looming uncertainty about the depth and duration of the crisis,
by Lynn S. Paine the decision became a complex matter of weighing and balancing multiple factors
October 06, 2020 — at least for companies flush enough to consider it at all.

Boardroom dividend discussions ranged over a series of considerations: the equity

and symbolism of returning cash to shareholders at a time when employees were
being laid off or furloughed; the potential future opportunities gained (or lost) by
following (or going against) government calls for dividend cuts; the reputational
and signaling effects of maintaining versus suspending or reducing the dividend;
the expectations of shareholders and the proportion reliant on dividend income;
the company’s cash position and strategic plans; and what would be prudent in the
face of extreme uncertainty. A decision that would typically require only a few
minutes of board discussion — if that — became an hour-long (or more)
deliberation. And then there was the discussion about how to explain the decision
in the company’s public communications.

In the end, some boards decided to maintain the dividend. Others decided to
HBR Staff/cherezoff/t_kimura/Getty Images
suspend or reduce it. In the U.K. and Europe, where policy makers and central
banks urged cuts, the major banks and many companies followed their guidance. In

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the U.S., most of the large banks committed to maintaining their dividends, though
authorities and experts disagreed about the wisdom of that choice. Whatever the
final decision, however, the process of reaching it was far from straightforward.
This is just one example of the reality that boards are facing as a result of Covid-19.
The new environment is characterized by an increasingly complex set of pressures
and demands from various stakeholder groups, heightened expectations for
societal engagement and corporate citizenship, and radical uncertainty about the
future. These factors are complicating board decision-making and challenging the
shareholder-centric model of governance that has guided boards and business
leaders for the past several decades.
The shareholder-centric model, which is based on what academics call “agency
theory,” appears to be giving way to a richer model of governance that puts the
health and resilience of the company at its center. The pandemic has made all too
clear that society depends on well-functioning companies to meet its most basic
needs — for food, shelter, communication, you name it — and that companies do
not exist solely to maximize returns to shareholders. It follows that boards, which
by law are a company’s governing body, should be concerned not just with returns
to shareholders, but with the full range of factors that enable the company to create
value over time. Paradoxically, this enlarged purview does not diminish boards’
accountability to shareholders, but it does imply changes in the nature and scope of
that accountability.
Whether Covid-19 is truly an inflection point for corporate governance is yet to be
seen, but there is no doubt that the pandemic has challenged core premises of the
agency-based model of governance in ways that have important implications for
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boards. In this article, I discuss several of these challenges and suggest five ways
the board’s job is likely to change in the post-Covid era. As boards go through their
annual self-assessment process, they will want to review their capabilities and
readiness in each of these areas.
Read a list of questions and statements boards should consider including in their self-
evaluation.
More Structured Attention to Stakeholders
Shareholder primacy is the cornerstone of the agency-based model of governance,
but if the pandemic has shown anything, it is the importance of each and every
stakeholder group to a company’s ability to function, let alone thrive and succeed
over time. In the face of Covid-19, some companies struggled because their
customers disappeared. Others saw their workforce reduced to a skeleton crew of
essential employees. Still others grappled with supply chain disruptions,
unsustainable debt, or insufficient capital to fund their operations. Since the onset
of the crisis, it has become common practice for management to update the board
on the situation regarding each stakeholder group, and many boards and senior
leaders have declared the health and safety of employees and customers to be their
top priority. Some investor groups as well have weighed in on behalf of putting
employees first during this perilous time.
The crisis has validated the logic of interdependence behind the Business
Roundtable’s 2019 statement on corporate purpose, in which 181 CEOs pledged a
commitment to each of five stakeholder groups — customers, employees, suppliers,
communities, and shareholders — and reversed its endorsement of shareholder
primacy. Coming out of the crisis, boards and senior leaders will find it even harder
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to say that shareholders — or, for that matter, any stakeholder group — has
standing “primacy” over all the others. The crisis has demonstrated that the
“primacy” of one group or the other cannot be fixed once-and-for-all. In the life of
a company, there are times when employee interests must come first, times when
customer interests should take priority, times when public need is paramount, and
times when the interests of shareholders should be the prime concern. As reactions
to Covid-19 showed, much depends on the nature of the interests at issue and the
circumstances of the company.
These lessons from Covid-19 imply a more active role for boards in monitoring
companies’ relationships with their core stakeholders. That may mean asking
management to continue the Covid-born practice of periodic reporting to the
board on the status of each group or, more formally, to establish goals and a
reporting process that will allow the board to track the company’s performance for
its stakeholders more systematically over time. Boards will also want to take a
more active role in ensuring that tradeoffs among the interests of its various
stakeholders are handled in a way that is consistent with its obligations to these
groups and with the long-term health of the company. For that, it will be important
for directors to have a shared understanding of the company’s purpose and
strategy, as well as a framework defining the company’s stakeholders and
responsibilities to each.
Many companies say they have commitments to all of their stakeholders, and that
may well be true. But few boards have a structured process for overseeing those
commitments or for tracking the company’s performance for its non-shareholder
stakeholders. If they do, it is not something that is regularly reviewed and
discussed in the boardroom in the way that performance for shareholders is
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regularly reviewed and discussed. To the extent that stakeholder concerns come
into strategy or M&A decisions, it tends to be somewhat ad hoc or by exception
rather than a routine part of the analyses that boards receive.
In the wake of Covid-19, boards will likely face increased pressure to incorporate
stakeholder perspectives and voices, especially those of employees, into their
oversight and decision processes. They will also be challenged to show that the
company is performing well for all its stakeholders. External pressure aside, boards
that have learned from Covid-19 will want to do this for their own purposes.
More Attention to How Business and Society Intersect
The pandemic has brought home the tight connection between business and
society, and underscored the threat posed by risks stemming from large-scale
societal problems that proponents of the shareholder model have traditionally
regarded as outside the purview of business. The pandemic has shown that, theory
aside, companies cannot so easily disconnect themselves from society-at-large.
Covid-19 started as a public health crisis and quickly evolved into a financial and
economic crisis of epic proportions. As the virus made its way across the globe,
few, if any, companies were spared. Some saw demand for their offerings collapse
overnight, while others faced a deluge of orders. Many had to invent new ways of
working in a matter of days, if not hours. Stock prices plunged and then fell into a
pattern of unprecedented volatility. In the face of uneven and, in some cases,
ineffective responses by governments and with economic recovery dependent on
stemming the public health crisis, many companies stepped up to fill the gap even
as they struggled with their own problems. In the many meetings and updates
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during this period, directors found themselves reviewing management’s plans not
only for steering the company through the crisis but also for helping combat the
virus or aid in the relief effort.
Many companies rose to the occasion, retooling their production lines to make
needed equipment, providing open access to otherwise proprietary information,
offering their facilities or services to health authorities, or bringing their
capabilities to bear on the crisis in other ways. Others acquitted themselves less
well, and got caught in the public’s crosshairs for seeking to take advantage of
government programs intended for those less fortunate. Many boards and senior
leaders were forced to grapple with vexing questions of public responsibility at the
same time that they were struggling with a crisis for which they were ill prepared.
For at least a decade, calls have been mounting for business to help address
systemic concerns such as increasing income and wealth inequality, environmental
degradation, climate change, racial and ethnic discrimination, declining public
health and education, rising corruption, deteriorating public institutions, and, yes,
increasing risk of pandemics. While some business leaders have heeded the call and
found innovative ways to help address these problems, many others have looked
the other way or defined the problems away as “social issues” or what economists
calls “public goods” problems and therefore, by definition, outside the scope of
their legitimate concern as business executives and fiduciaries for their
shareholders.
Covid-19 has shown that these issues are not only legitimate areas of concern for
business but also, and more importantly, sources of both risk and opportunity.
Like market forces, societal forces can profoundly affect the business and
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competitive environment. Coming out of the crisis, boards will want to work with
their company’s leaders to ensure that the company’s risk management and
oversight systems encompass the risks arising from these large-scale societal
problems. They will also want to ensure that the company’s strategic planning and
resource allocation processes take these problems into account, so that the
resulting activities, at a minimum, do not exacerbate these problems and, ideally,
help to ameliorate them.
In the wake of Covid-19 boards can expect institutional investors, governments,
and the general public to renew their calls for companies to pay more attention to
societal problems and to take a more active role in helping address them. By the
same token, boards themselves will increasingly be expected to oversee the
business and society interface. Instead of being the exception, robust oversight
over sustainability, corporate responsibility, societal engagement, corporate
citizenship, ESG — whatever you want to call it — will become the rule.
More Comprehensive Approach to Compensation
The pandemic has laid bare glaring disparities in pay across society and within
companies. It also has brought to the surface several problems with the
shareholder model’s traditional pay-for-performance paradigm, most notably its
indifference to issues of equity (in the sense of fairness, including across gender
and race) and to externalities such as impacts on third parties and the
environment. The pandemic has also tested the paradigm’s suitability for
conditions of extreme uncertainty when the motivational theories behind it are
difficult to implement.
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In its classic formulation, the paradigm defines “performance” solely in terms of
returns to shareholders and treats pay as a tool to motivate executives to act in
ways that will maximize those returns. In practice, this has evolved into a system
in which boards set targets for actions or outcomes that they think will lead to
shareholder returns and offer executives the prospect of large rewards in the form
of cash or stock if — but only if — they achieve the targets. According to the
theory, the prospect of the reward motivates executives to work harder than they
would otherwise to achieve the targets.
What should boards do, though, when a surprise downturn renders the targets
irrelevant, which is what happened in the pandemic? When revenues collapsed in
the wake of the lockdown, targets that boards had set just a few months earlier to
determine eligibility for cash bonuses and stock awards became instantly
unachievable. Given the large proportion of executive pay dependent either on
meeting the pre-set performance targets, boards were confronted with the problem
of retaining and motivating the executives whose talents were sorely needed to see
the company through the crisis. At the same time, the obvious solution of adjusting
targets downward seemed to make a mockery of the whole notion of pay for
performance, especially considering that targets are never adjusted upwards when
unexpectedly favorable conditions make them easy to achieve. And few directors
relished the idea of protecting the pay of those at the top while those same
managers were simultaneously laying off or furloughing large swaths of the
workforce during a time of general hardship.
The dilemma was all the more acute because of the gross disparities in pay between
executive and management employees and those on the front lines in positions
deemed essential to society’s functioning during the crisis. These “essential”
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workers not only bore the brunt of potential exposure to Covid-19, but they also
tended to be the least well paid and the most vulnerable to health and financial risk.
Boards and senior leaders navigated this thicket in various ways. Some executives
took temporary pay cuts in an effort to show solidarity with employees. Some
companies handed out special one-time bonuses to those on the front lines. Some
boards have, indeed, adjusted targets and thresholds downward, repriced options,
or given executives new shares or stock options. But it is clear that these
measures, while responsive to the moment, do not solve the larger problems of
compensation design revealed by the pandemic.
For years, textbook teaching has held that boards should design pay so as to align
the interests of executives with those of shareholders and that high-powered
incentives are necessary to motivate executives to do their jobs. These ideas have
created a system that is now deeply entrenched in practice even as research has
revealed its flaws and even as enlightened shareholders have themselves called for
tying pay to a broader set of factors linked to the company’s strategy,
environmental impact, or social performance. Before the pandemic some boards
were heeding the call, adding new measures of performance or otherwise seeking
to align pay not just with short-term shareholder returns but with the longer-term
health of the company and the needs of society. A few had linked executive pay
with reductions in carbon emissions or with diversity and inclusion measures.
With Covid-19 and the reckoning over racial inequity fueling new and more urgent
calls for economic justice, it is only a matter of time before boards will be asked to
justify the compensation paid not only to their top executives but also to rank-and-
file employees, and to do so not just to shareholders but also to the broader public.
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As the social and economic context continue to evolve, compensation committees
will want to broaden their mandate beyond executive pay to include oversight over
compensation policies across the organization. They will also want to make sure
that their compensation programs are aligned with the company’s strategy and
societal commitments, perceived internally as fair and equitable, and well suited
for what is likely to be continuing market uncertainty.
More Deliberative Decision-Making
As noted earlier, Covid-19 has complicated board decision-making and made it less
amenable to general rules and simple formulas. The injunction to “maximize
shareholder value” just does not have much purchase when it comes to deciding
how much to invest in personal protection equipment to safeguard employees’
health or whether to convert an auto manufacturing line to the production of
ventilators for a nation in need. Indeed, the pandemic has called into question
many pre-crisis decisions that were taken in the name of maximizing shareholder
value but that left those companies strapped for cash, saddled with debt, or
otherwise ill-equipped to cope with the damage wrought by Covid-19. In this new
environment, boards are increasingly having to rely on qualitative judgments in
forming opinions and reaching decisions.
To be sure, the decisions that boards are called on to make have always required
some measure of qualitative judgment. Adages aside, the numbers frequently do
not speak for themselves, and many issues that rise to the board are not amenable
to resolution through financial analysis or other quantitative techniques. That’s
why deliberation and debate have always been important in the boardroom and
why the capacity to engage in such discussion is a critical skill for board members.
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The pandemic, however, has amplified the importance of judgment and,
correspondingly, increased the amount of time that boards are spending in
deliberative discussions exploring different options and weighing competing
considerations and perspectives. That’s, in part, because boards are having to deal
with novel issues and matters for which they have no precedent or policy. Before
the pandemic, for instance, few companies had policies and guidelines on virtual
shareholder meetings, so when they emerged as a possibility, boards had to explore
and assess the alternatives and implications quickly and carefully.
But the increased need for deliberative discussion is also a result of changes in the
context that have upended pre-Covid business models. Fractured strategies,
heightened uncertainty about the future, increased scrutiny from multiple
audiences, and the need to perform well for all stakeholders — all of these factors
are making it necessary for boards to consider a richer and more varied set of
inputs and perspectives.
Consider the dividend decision discussed earlier: Instead of focusing just on the
company’s cash position and shareholder expectations, boards had to consider the
perspectives of employees, governments, and the public, and of differing groups of
shareholders — and each group’s likely reactions to the various possible decisions.
Boards also had to consider issues of fairness and the possible ramifications of
taking action that might be perceived as unfair to the public or to employees,
especially if the company was expecting to benefit from government assistance
programs. Boards also had to think about alternative scenarios for how the
pandemic might evolve and what those scenarios implied for the company’s
strategy and future cash needs. Through a process of deliberation, these differing
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factors and perspectives had to be weighed and prioritized; alternative courses of
action examined; and, ultimately, a decision made as to what would be best, all
things considered, for the company given its particular situation.
In this and many other areas, Covid-19 has raised the bar on deliberation and
judgment in the boardroom, but the underlying factors driving this development
will most certainly outlive the pandemic. Companies will continue to face a
complex and uncertain environment in which they are nevertheless expected to
meet multiple objectives and answer to a diverse group of audiences. As boards
work with management to chart the company’s post-Covid strategy and allocate
resources as between current and future needs of the business, they will need to
spend more time considering the claims of different stakeholders and reviewing
the potential impacts of their decisions under various possible future scenarios.
They will also need more and better information to support these discussions.
This analysis suggests that a board’s ability to deliberate in a thorough and
thoughtful, but efficient, manner and come to a considered conclusion will be a
critical aspect of its effectiveness in the post-Covid era. As of today, directors and
boards vary widely in their appetite and capacity for this sort of discussion. Board
chairs, as well, differ in their ability to facilitate it. This is another area in which
forward-thinking boards will want to assess themselves and, if needed, take steps
to raise their game.
More Attention to Board Composition and Director Race and Ethnicity
The pandemic’s disparate effects and ensuing national outcry over racial inequity
have put a spotlight on board composition, especially as it relates to directors’ race
Stay informed with the
and ethnicity, a topic on which the agency-based model has been ambivalent at
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Daily Alert
best. In his classic article on corporate social responsibility, economist Milton
Friedman portrays the ideal “agent” (the theory’s term for a director or manager)
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as a generic male wholly devoted including
to maximizing the on
new resources wealth
leadingof
andshareholders
working throughto
a the
pandemic.
point of suppressing his own personal commitments — and even his
responsibilities to family and community. In other
Get it in your inbox words, the theory regards
directors’ identities and personal characteristics as largely irrelevant for their roles.
This void in theory has been filled in practice by a custom of appointing directors
with backgrounds as CEOs or CFOs, positions traditionally held by white men, and
of drawing board candidates from existing directors’ own networks. The result has
been a self-perpetuating system of boards populated mainly by white men of a
certain seniority and background. Over the past decade, the gender disparity has
been moderated somewhat by the push for more female directors. According to a
study of Russell 3000 companies by Institutional Investor Services (ISS), the
percentage of board seats filled by women went from 9% in 2009 to 19% in 2019.
But racial and ethnic disparities persist and they are stark. Another ISS study
found that only about 12.5% of directors at the nation’s 3,000 largest companies
are members of racial or ethnic minorities, even though these groups make up 40%
of the U.S. population. According to a 2019 study by Black Enterprise, nearly 38%
of S&P 500 companies have no black directors on their boards.
A board’s role is to provide strategic guidance and oversight, and directors must
bring the appropriate skills to address a company’s specific business needs and
circumstances. The pandemic and the national awakening to racial inequities in all
walks of life have made it abundantly clear that a diversity of experience and
perspective in the boardroom is also crucial for boards to do their job. Monitoring
the company’s relationships with its stakeholders, assessing strategy, overseeing
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risk, reviewing societal engagement, assessing pay practices, overseeing
management’s diversity and inclusion efforts — these are just a few of the standard
board tasks for which the insights of directors from different racial and ethnic
groups would appear to be essential inputs. Studies have shown that the addition
of female directors has altered board discussions and made them more robust. The
addition of more directors from underrepresented groups is likely to have a similar
effect.
Quite apart from the benefits to companies and from the moral case for affording
individuals of all races and ethnicities the opportunity to be considered for board
positions, the inclusion of directors from minority communities is also important
for combatting the racial inequities that cut across society. Experts say that the
pandemic’s disproportionate effects on African Americans and other
underrepresented minorities are driven in no small part by social and economic
disadvantages borne by these groups. These disadvantages are unlikely to be
rectified until more leaders who understand these problems occupy positions of
power and influence in business and the boardroom.
Pressure to take action continues to mount. Institutional investors are already
calling on boards to disclose their plans for adding Black and other
underrepresented directors to their ranks, and at least one shareholder lawsuit has
been filed against directors alleging breach of fiduciary duty based on the board’s
lack of racial diversity. California lawmakers recently passed a bill that would
require the boards of publicly traded companies with headquarters in that state to
appoint at least one director from an underrepresented community by 2021. Some
companies have pledged to add Black or other underrepresented directors of their
own accord.
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Boards that have not done so will want to review their director skill matrices and
their board succession plans with an eye to enhancing racial and ethnic diversity in
a way that is consistent with the company’s strategy and the board’s need for other
types of diversity — industry, geographic, domain expertise, gender, and the like.
For many boards, it will be necessary to develop new channels for identifying
talent, new approaches to onboarding directors, and more deliberate processes for
building board cohesion in order to achieve their goals and realize the benefits of
having a board whose membership is truly diverse.
Overall — A More Demanding Job
In summary, Covid-19 has made the director’s job more demanding. Since the
onset of the pandemic, boards have been getting more frequent updates from
management and having shorter, more frequent meetings to deal with a multitude
of issues that have presented themselves. Surveys indicate that most directors are
spending more time on the job. While the frequency and intensity of meetings is
likely to decline somewhat as the crisis subsides, the new expectations of boards
discussed above will inevitably require directors to devote more time to their role
than has customarily been the case. Working more closely with management on
strategy, tracking a richer set of performance measures, overseeing an expanded
menu of risks, rethinking compensation policies, engaging in more thoughtful
deliberation, reviewing board composition — all of these activities take time. And
the ease of convening virtual meetings means that the new cadence is likely to
include shorter, more frequent virtual meetings as well as periodic in-person
meetings, once travel restrictions are lifted and safety can be assured.
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As boards look to the post-Covid era they will want to assess their readiness to
meet the new demands, and develop a plan to address any gaps they find. At this
moment, when old assumptions are being questioned, they will also want to ensure
that their members have a shared understanding of the board’s role and
responsibilities, and of their individual role and responsibilities as directors. In the
flurry of Covid-inspired activity, it is important that boards not lose sight of their
central functions as governing bodies of the companies they serve.

Lynn S. Paine is Baker Foundation Professor, John G. McLean Professor of

Business Administration Emerita, and Senior Associate Dean for International
Development at Harvard Business School. She is a coauthor of Capitalism at Risk:
How Business Can Lead.

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