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The Evolution of Governance: A Scenario for Best Practices in 21st Century Governance

A Discussion Paper

September, 2006

Rob McLean and Ron McCullough

BenchmarkAction Inc.

1. Introduction

The purpose of this paper is to lay out a set of ideas that are intended to stimulate discussion among governance professionals about where corporate governance is headed.

The scenario for 21st Century Governance that is explored in this paper describes an important shift in which governance is held accountable not just for oversight, but also for adding value in a way that enhances the performance of the organization. In practical terms, governance will move beyond the meeting-centric nature of today’s processes, toward a more systemic set of processes including a variety of activities and events designed to achieve a broader set of outcomes. These processes will be managed by an enhanced “CGO” function or secretariat, supported by dedicated systems and technology.

What matters about this paper is not whether all or any of these ideas are “right”: what matters is whether discussion about them leads to insights for individuals and the community of governance professionals about what the future might hold.

Most importantly, dialogue and debate will deepen understanding of the potential implications of this scenario for 21st Century Governance, about the priorities for collective action, and about how we can get there from here.

The impetus for this discussion paper emerged from a series of focus groups organized by Lynn Beauregard and her team at ICSA. Valuable input was provided by Lynn and her colleagues, the ICSA Executive, and the many governance professionals who contributed time and thoughts during the past six months.

2. A Scenario for the Evolution of Corporate Governance

Corporate governance is clearly evolving, both in theory and practice.

The following chart maps various characteristics of corporate governance in the ancient past, the recent past and present, and a potential scenario for the future. (Of course, like all generalizations, these observations are only accurate some of the time.)

According to this hypothesis, some of key changes as we move toward 21st Century Governance are:

• A wholesale shift in leadership, as the baby-boomers and Generation X take over the Boardroom;
• A new emphasis on contributing to the leadership of the organization in a way that goes beyond oversight, resulting in performance that exceeds what can be achieved based on the efforts of the management team alone
• A shift away from governance conceived of as a meeting-centric process focused on the Board and its committees, to governance conceived of as a complex system, in which multiple processes, including but not limited to conventional in-person meetings, combine to deliver the desired outcomes;
• The emergence of a new Chief Governance Officer function or secretariat, reporting at the C-suite level, with the principal task of ensuring that governance processes are organized to achieve the desired outcomes;
• The development of a new set of underlying systems and technology to manage governance-related priorities, manage and track performance, ensure compliance, manage governance processes and events, and keep track of related documents and information.
• The emergence of reliable and robust methods to assess governance performance and its impacts from both internal and external perspectives.

What’s driving this evolution? The following diagram suggests that regulator-push was the most important driving force for change in the past five to ten years, as capital markets regulators belatedly reacted to the multi-trillion dollar misallocation and misappropriation of resources rather innocuously labeled the “tech bubble”, and the less damaging, but more notorious financial scandals such as WorldCom and Enron.

Looking ahead, regulator-push will continue, but will be a less dominant force for change. Demographic change is always a factor, but in this instance, there is some evidence that baby-boomers and gen Xers have different values and priorities than the generation that has dominated boardrooms for the past 20 years.

One of the forces driving future change is the emergence of new frameworks and systems that make it possible to measure the degree to which a particular organization demonstrates best practices in governance. These include various external governance rating schemes (all of which are still embryonic), as well as internal self-assessment systems. The ability to benchmark Quality Management practices was a key factor in the quality revolution of the 70s and 80s. In a similar way, the ability to benchmark governance practices will have a profound impact, introducing a degree of transparency that will banish forever the club-like atmosphere of the boardrooms of the past.

There is on-going debate about governance Return On Investment. Such debates must be viewed in the context of the ability of good governance to build long term value creation potential in an organization from a strategic perspective. In the Information Revolution of the 80s, organizations that recognized a new strategic role for information management were rewarded. Similarly, organizations that manage governance as part of the value creation process will achieve long-term strategic advantage.

It is incontrovertible that the concept and practice of measuring corporate performance is in the midst of a paradigm shift. In the past, financial statements were the principal, if not the only, yardstick by which a corporation’s performance was measured. Gradually, the business world is waking up to the fact that financial statements are based on a transactional accounting model that is inherently incapable of providing insights about the organization’s future value creation potential, or its ability to create value for stakeholders other than shareholders.

While the successor to the transactional accounting paradigm has not yet been perfected, there are well over 100 experiments underway around the world testing various alternative measurement approaches. The precursor to broader measurement is the Management Discussion and Analysis (MD&A), but the current MD&A is in reality a placeholder for more reliable, comprehensive and forward-looking methods of measuring corporate performance. As these emerge, they will have a profound effect on corporate governance.

To grasp this, imagine what it will be like when Boards put as much effort into monitoring all aspects of corporate performance as today’s Audit Committees put into overseeing financial statements and the financial audit.

3. 21st Century/Systemic Governance: Function and Defining Characteristics

One of the fundamental changes in 21st Century Governance will be a shift in the understanding of the function of governance. The most dominant view today, at least in practice, is that the function of governance is oversight: that is, to look over the shoulders of management on behalf of the shareholders, and ensure that management is doing a good enough job.

According to the 21st Century Governance hypothesis, oversight is still necessary, but not sufficient. Good governance in future will be measured by the degree to which it adds value to the outcomes that would be achieved by the management team on its own.

Of course, many will argue that governance today already adds value to the efforts of management. For instance, there are many CEOs who populate their boards with people who have the capability to contribute insights that influence the strategy of the organization. In addition, the idea that governance should add value is not new: for instance, in one form, it was articulated by the Joint Committee on Corporate Governance in 2001.

What will be different about 21st Century Governance is that the governance system will be specifically designed to add value, in addition to providing oversight, and this added-value will be measured. The vast majority of governance systems in today’s corporations are designed principally to provide oversight: if governance also adds value, it is because of the specific people involved, not because the system has been designed to achieve that outcome.

These observations beg the obvious question: what would a governance system look like if it were designed to add value?

One way to answer this question is to focus on the interfaces between the elements of a governance system, and key business processes. As suggested by the diagram below, the elements of a governance system include at least the board, committees, C-suite executives, key stakeholders, and the CGO function. Key business processes include strategy, business planning, and the others listed below.

Consider the interface between governance and the business processes related to R&D / Innovation. There is currently no mandated compliance governance oversight responsibility relating specifically to R&D / Innovation. However, arguably, there is no business process that is more important than R&D / Innovation to the ability of the corporation to generate new value streams in future.

What role should governance have with respect to R&D/Innovation? Should there be an oversight role, perhaps related to allocation of resources? Should governance be concerned with whether the R&D/Innovation processes are robust and capable of generating competitive advantage? Can governance add value to the organization’s R&D/Innovation business processes?

There can be no absolute answer to these questions. If the organization’s R&D/Innovation processes are robust and leading edge relative to peers and competitors, and if there is evidence that resources are being invested in such a way as to generate satisfactory future value creation potential, there is little need for added value from governance. If these criteria are not met, however, then oversight is not sufficient: the governance system needs to add value.

This example illustrates that effective 21st Century Governance will be highly situational in nature: priorities for added value from the governance system can only be determined based on an understanding of the robustness and competitive positioning of the organization’s key business processes. One of the potential responsibilities of a CGO function or secretariat is to manage the processes that identify priorities for added value from the governance system.

These concepts lead to a delineation of the defining characteristics of 21st Century Governance as illustrated by the following diagram.

Systemic process management: Rather than a meeting-centric process as is normally the case today, governance in future will be conceived of and managed as a complex system with many moving parts. Governance processes will include various types of activities and events: of course, Board and committee meetings will still take place, to define desired outcomes, plan activities, track progress, and make key decisions. But some of what currently happens in today’s meetings will be organized differently as asynchronous processes under the leadership of specific individuals who have been delegated responsibility on behalf of the Board or Committee.

Governance Best Practices Positioning: To be effective at setting priorities and direction, organizations will need to know what are governance best practices (at least the ones that are relevant to their specific situation), and how the organization is currently positioned relative to those practices. Acquiring this knowledge will involve a combination of external assessments by third parties, internal self-assessment, and some form of benchmarking.

CGO function / secretariat: Effective management of 21st Century Governance processes will require that there be a corporate function or combination of functions with the responsibility and capability to:

• assess and manage compliance in the governance domain;
• gather the information needed to determine governance priorities and desired outcomes for oversight and/or added value relating to specific business processes;
• manage governance processes, including a wide variety of activities and events;
• track progress toward defined outcomes;
• manage the documents and information-flows needed to support all of the above activities.

Whether these capabilities are concentrated in one organizational unit or spread out, in combination they constitute a CGO function or secretariat. To be effective, this function will require delegated authority from both the CEO and the Board chair. In smaller organizations, the CGO role might be assumed by an existing C-Suite executive such as the CFO. In larger organizations, a dedicated CGO role could be filled by someone with a legal, corporate secretarial, or management background.

To those who are skeptical about the governance function as an executive C-suite role, think about the evolution of the Chief Technology Officer (CTO) and Chief Information Officer (CIO) roles as they have emerged over the past two decades. The CGO of the future will be seen as making as important a contribution to the performance of the organization as the CTO and CIO, and like the CTO or CIO, will sit at the center of a complex matrix of accountabilities.

Technology-enabled Tools/Systems: To accomplish its responsibilities, a CGO function will require dedicated technical and systems support. Systems customized to the needs of the CGO function will emerge (and in some cases, already exist) related to:

• best practices and positioning assessment;
• defining desired outcomes and priorities;
• process management;
• compliance management;
• document and information management.

Enhanced corporate performance measurement: To meet the demands of 21st Century Governance, measurement systems will emerge that will continue to provide information about financial performance and compliance, but will also provide participants in governance processes with insights about the organization’s positioning in important performance domains, key trends with respect to future value creation potential reflecting the perspective of multiple stakeholders, and the overall strategic positioning of the enterprise. While this measurement information will emerge from various parts of the organization, coordination and packaging of this information to support governance processes will in many organizations be part of the CGO role.

4. How do we get there from here: introducing the GovernanceExcellence Network

If any of the ideas above about 21st Century Governance are accurate, we have a lot of work to do. To enable a transition to systemic governance, we must address the following requirements:

In considering how the governance community could make progress toward meeting these requirements, two key ideas emerged.

• The first was to create a virtual space where governance professionals could work together to strengthen the foundations for 21st Century Governance. Of course, many existing governance-related organizations are working on parts of the solution, and the intention is not to duplicate any of that work. Rather, the opportunity is to foster cross-functional collaboration between organizations representing directors, lawyers, accountants, corporate secretaries and other governance professionals.
  
  
• The second idea was to gather together an initial set of practical tools that governance professionals can use in their various organizations to assess and benchmark best practices, and from that initial foundation, stimulate continued development of the entire set of systems and technologies that will be necessary to support 21st Century Governance.

In sum, from a series of conversations, there emerged the concept of a GovernanceExcellence network or community, designed to respond to the identified requirements as follows:

Initial steps have been taken to establish the GovernanceExcellence Network, and further activities are planned, but it will only achieve its potential if governance professionals participate, and direct its evolution in a way that serves their needs.

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We're interested in your comments on the ideas in this paper. Please see the 21st Century Governance Comments link.