Question
Some commentators suggest that the modern iteration of corporate governance in the United States began in the 1970s.[1] So, in 2023, what do we mean by the term “corporate governance”?
Does it just mean the set of legal rules and norms addressing the conduct of directors and officers of a corporation? Does it necessarily include mechanisms of regulatory oversight such as those applied to public companies and certain industries such as banking and certain functions such as privacy? Does it necessarily include criminal laws? Is it more than that?
And, if it is more than just the legal rules and norms addressing the conduct of directors and officers of a corporation, how should we make regulators more effective at enforcing corporate governance norms? Are there other regulatory agencies, federal or state, that should have a direct role in corporate governance?
What about member organizations like the NACD? What should its role be in developing norms for directors? Are organizations like the NACD potentially more effective because they explain the role of the board in terms that non-lawyers can understand?
Answer
I like this question a lot. But I will use it as a jumping off point for flagging the importance of non-legal aspects of corporate governance; specifically, best practices. In 1982, Thomas Peters and Robert H. Waterman expanded upon Xerox's practical approach in their influential book, "In Search of Excellence: Lessons from America's Best-Run Companies." Their work brought the concept of best-practices research and implementation into the mainstream of American organizations. The authors conducted a comprehensive study, analyzing sixty-two American companies spanning various industries, and identified eight attributes that they believed epitomized the excellence of America's most innovative entities. With over three million copies sold and a long stint on bestseller lists, Peters and Waterman succeeded in popularizing the adoption of best practices as a strategy for gaining a competitive edge by emulating the most effective strategies of competitors.
As the number of success stories multiplied and the popularity of best practices soared, three primary styles of benchmarking emerged: competitive benchmarking, cooperative benchmarking, and collaborative benchmarking. Competitive benchmarking involves gathering information from competitors to establish a benchmark. This approach entails measuring your functions, processes, activities, products, or services against those of your competitors and continually improving them to attain best-in-class status. Cooperative benchmarking necessitates a company seeking improvement in a particular activity to reach out to a best-in-class firm and request knowledge-sharing with the benchmarking team. Collaborative benchmarking, on the other hand, involves companies coming together to exchange information about an activity with the aim of enhancing their internal processes based on the acquired insights. Ideally, as more companies adopt best practices and engage in cooperative knowledge-sharing, the resulting impact will be widespread, fostering further innovation.
Despite facing its share of critics, the best-practices methodology undeniably remains a common and highly regarded practice among many modern organizations. Most large corporations now engage in at least one form of benchmarking to develop and implement best practices.
The NACD has played an important role in developing and promulgating best practices. The NACD’s Corporate Governance Guidelines, for example, incorporate both legal rules and norms of best practice.
But given the emphasis in your question on the role of regulatory agencies, it would be worth having a discussion of whether the United States should follow the lead of the United Kingdom in having a regulatory body that develops best practice codes.
The UK Corporate Governance Code acknowledges that effective corporate governance cannot be achieved through a one-size-fits-all approach, recognizing that different companies may require different methods. Consequently, it allows for flexibility and permits companies to deviate from the Code, provided they offer a rationale for their non-compliance.
In their annual reports, companies are expected to disclose whether they have: a) fully adhered to all aspects of the Code's Provisions throughout the entire financial year; or b) departed from any of the Code's Provisions (either for the entire financial year or a portion thereof), specifying the Provisions they have not followed and indicating where in the report the explanation can be located.
It's crucial to note that the Code serves as a framework for best practices rather than a strict set of rules. It comprises adaptable requirements. In instances where a company has justified non-compliance with a Provision, it falls upon investors to assess whether the explanation is satisfactory and demonstrates how deviating from the Code benefits the company. In cases where explanations are deemed inadequate, investors are encouraged to engage with the companies and hold directors accountable, with the aim of enhancing governance practices and reporting standards.
[1] See e.g., https://www.thecorporategovernanceinstitute.com/insights/lexicon/why-does-corporate-governance-matter-a-look-back-at-history/
