A New Era in Corporate Governance

Directors and investors are demanding reform. Companies had better prepare for it.

A final reason for action is the upcoming battle for director talent. The combination of Sarbanes-Oxley, which has materially increased the time boards must spend on their fiduciary responsibilities, and investor pressures for board accountability is changing the value proposition of service as a corporate director. The rewards—prestige and compensation—may remain the same, but the risks have grown. Fewer high-caliber people will therefore be willing to serve on boards in coming years. In addition, some companies have adopted limits on the number of boards that their CEOs and other senior executives can serve on. As the talent pool of directors begins to shrink, the best ones will favor companies that have adopted the best governance practices. The remaining companies may have to resort to second-string directors and then confront a vicious cycle of board decline.

The impact of this deterioration may be felt in both the quality of a board’s oversight and the capital markets’ perception of a company’s trustworthiness. As the quality of board members falls off, so too will the quality of the board’s oversight and advice. For anyone—like most of the directors in the survey—who believes that a board’s performance can significantly affect a company’s, this will be an omen of continuing decline. As corporate performance sags and boards become weaker, they will have an increasingly difficult time attracting suitable new members.

Substantial progress has recently been made in US corporate governance, not least because of the new Sarbanes-Oxley Act. Yet investors and directors are clearly calling for more—and deeper—reforms. Boards that embrace them may well reap a trust premium,(Roberto Newell and Gregory Wilson, “A Premium for Good Governance,” The McKinsey Quarterly, 2002 Number 3, pp. 20—23.) while those that continue to ignore the call for change serve neither management nor the shareholders well.

The author, Robert F. Felton, is a director in McKinsey’s Seattle office.

Information Technology’s Role in Governance

The directors and senior executives with whom we work say that the most critical requirement in corporate governance is raising the quality of the strategic dialogue between the board and management. To do so, both sides must see timely information that shows a company’s progress in implementing its strategy—information that isn’t necessarily found in quarterly financial filings or in today’s board books. What’s needed is a set of consistent, unbiased reports, delivered routinely to all board members, that paint a broad picture of the company’s situation.

Most companies will need to change their IT systems in four ways to achieve this goal. First, they must ensure the integrity of the data, which should be easily traceable back to original transactions. Managers and board members must be able to drill down through performance metrics to find the root cause of problems—or the genesis of opportunities.

Second, more attention must be paid to the timeliness of information, not only to accommodate shortened reporting deadlines, but also to facilitate faster, more flexible decision making. One CEO told us, “Getting data that is one or more months old just isn’t enough. . . . I need highly filtered, insightful data at least every other week, preferably weekly.” IT systems that are integrated across the company reduce the time needed to reconcile performance data and thus make it possible to deliver information rapidly.

Third, efficient IT systems will tailor reports to the needs and capacity of individual users—from board members looking for insights on strategic risks to managers comparing regional sales data. IT systems should deliver information on business drivers to decision makers according to their individual responsibilities and requirements. One controller told us, “The trick is to move from mountains of data, all synthesized from different sources with different methods, to delivering targeted, consistent, context-specific information. . . . This is hard but drives real performance.”

Finally, companies should standardize the gathering of data for reports and automate them where possible to create a common, company-wide set of performance metrics—a basic good-governance requirement that a surprising number of companies lack. Standard performance metrics also make it easier to see exceptions and aberrations. The best systems deliver automated warning alerts to senior management and the board when key performance thresholds have been passed (positively or negatively) or use other feedback mechanisms to assure compliance with company policies and standards or with legal and regulatory requirements.

Companies that use their IT systems to improve corporate governance will probably improve their long-term performance as well. Given the effort and expense of meeting the rather narrow concerns of current compliance, the investment is very worthwhile. —Ken Berryman and Tom Stephenson

Ken Berryman is a principal and Tom Stephenson is an associate principal in McKinsey’s Silicon Valley office.

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