Trends shaping corporate governance in 2023 – Four areas to watch
Looking back on 2022
2022 saw upheaval with rising inflation, the war in Ukraine, energy price disruptions, and continued supply chain problems. There was action on the legislative and regulatory fronts too. Billed as the largest climate legislation in US history, President Biden signed into law the Inflation Reduction Act that includes tax credits and incentives to help companies tackle climate change. The pace of regulations from the SEC increased, and the EU finalized regulation of ESG topics that will impact US and other non-EU companies and their EU subsidiaries.
After the midterm elections, the new Congress returns to a divided government. Divided government is often viewed by businesses as a positive development as they believe it makes it difficult for comprehensive legislation favored by only one political party to become law. According to PwC’s latest Pulse Survey, 52% of respondents view a flip of the House of Representatives to Republican control as a positive change for business, compared to only 8% who believe it will have a negative impact and 34% who believe it will have no impact. But traditional policy paradigms have shifted in recent years, creating unlikely bedfellows on issues that have historically been favored by one political party or the other. So, businesses will need to remain vigilant.
Here are the four trends I’m watching for in 2023:
Trend 1: Responding to macroeconomic uncertainty
We face an unusual and uncertain economic situation—the potential for a recession with an odd confluence of factors—rising inflation, higher interest rates, low unemployment, and, for the moment, growth and high consumer spending. I see this uncertainty intensifying in 2023. It has been a decade since the last major recession. Given the potential risks, companies should leverage their longer-tenured directors while maintaining a balanced approach to board refreshment.
Last year, some companies began to focus on their enterprise risk management (ERM) process to identify priority areas and risks and developed strategies to respond. This year, when considering changes in strategy in response to the downturn, companies are more focused on long-term strategic initiatives necessary for growth. According to a recent PwC survey, despite the macroeconomic uncertainty, 83% of executives are focusing business strategy on growth as they confront today’s economic challenges. I agree—employing efforts focused on cost-cutting measures, like hiring freezes, for example, may have unintended consequences. Opportunistic competitors could attract great talent as others temporarily stop hiring or make reductions to their headcount.
Potential blind spots:
- Focusing on short-term uncertainty at the expense of long-term sustainability; balance is important
- Instituting a hiring freeze or headcount reduction without accounting for existing shortages in key business areas
Trend 2: Enhanced transparency in light of increasing responsibilities and pressures
Shareholders and regulators have shown increasing interest in understanding how boards execute their oversight responsibilities. In 2023, I expect boards to continue responding with increased transparency.
In preparation, boards are looking to collectively elevate their knowledge. Board education programs that focus on discrete topics, like cybersecurity and climate, will support this goal. But the most effective boards will use a multi-faceted approach, leveraging internal and external resources tailored for their needs, as well as continuing education.
Boards will also need to re-evaluate the allocation of responsibilities to maximize their effectiveness. The allocation matrix and reporting structure between management, committees, and the full board should be clear. This is especially true if the SEC’s final climate and cybersecurity rules include detailed governance disclosures as written in the initial proposals.
Boards are under pressure to identify directors with varied expertise (e.g., DEI, cyber). Before looking externally, they should consider whether (1) directors have the credentials and (2) existing disclosures effectively document their existing credentials and processes. Providing visibility into how directors meet their responsibilities—while holding themselves publicly accountable—is paramount in creating trust with all stakeholders.
Potential blind spots:
- Not evaluating if the board’s competencies align with how the business has evolved and oversight of new areas, like cybersecurity
- Relying on a point in time program or certificate to establish expertise in a topical area that is evolving quickly; it can lead to overestimating abilities
- Identifying a single board member as the expert in a topical area instead of collectively elevating the knowledge of all directors
- Limiting the audit committee’s oversight to financial disclosures when their process and controls expertise can be leveraged for disclosures being made in other documents, like the proxy statement and corporate sustainability report
Trend 3: Strain on talent
Companies are overhauling how and where work gets done at the same time that there is a generational shift in who is doing the work. As younger generations advance in the workforce, I see the best boards expanding their human capital oversight deeper into the organization to understand and address this shift. In addition, C-suite succession planning may need an overhaul to identify young leaders ready to succeed. Even against economic headwinds, companies should identify gaps in their talent and have upskilling plans to fill in the gaps. A talent pool that is diverse in many respects addresses this and other needs for different ways of thinking.
Companies can look outside the C-suite for gaps in talent. I have seen a shortage of talent in areas like legal, finance, and internal audit. This poses risks for companies, for example, in ensuring appropriate internal controls are in place. Companies may have to outsource responsibilities in response, but this comes with a price tag. Our paper, A deeper dive into talent management: the new board imperative, outlines how critical it is for boards to provide greater oversight of talent management at multiple levels of the organization and what directors can do.
Potential blind spots:
- Failing to align talent discussions with the ERM process—this could mean companies do not have the right talent for the risks identified
- Misunderstanding what motivates the next generation—flexibility, culture, well-being, reputation, and impact are key decision points for the next set of outperformers
Trend 4: Plain English reporting to the board
It’s clear that the scope of board oversight has expanded. When I meet with clients, I am consistently asked how the board can be confident that they are receiving the right information and asking the right questions. This is a difficult question to answer. Ultimately, it comes down to having a strong relationship and good dialogue with management. That starts with making sure that board materials are clear and designed to support their oversight responsibilities.
ESG is a great example. It would be impossible for the board to oversee every risk and topic that could be attached to the moniker. Further, processes to compile the information to produce a coherent narrative and supporting metrics for the company as a whole are just emerging. Seeking discipline in what information the board receives and its link to strategy will prepare the company to answer questions from a diverse set of stakeholders.
Another example is cybersecurity, where boards tell us they want better information. Less than half of board members (46%) who responded to our survey of corporate directors say they’re receiving consistent, decision-useful chief information security officer reporting to understand progress on key cyber risks. That information is mission critical in preparing for a cyber breach.
Our paper, Get boardroom ready: five ways to improve executive interactions with the board, focuses on preparing best-in-class board materials, knowing your audience, and presenting a clean message.
Potential blind spots:
- Not leaning into the board evaluation process to ensure efficient and effective practices
- Failing to establish a clear process for prioritizing ESG issues and spreading responsibility around the board and committees
- Relying on the SEC as the sole ESG disclosure authority, as our recent survey of corporate directors showed more than half of directors (54%) are either unsure or don’t understand if their company needs to comply with the EU’s Corporate Sustainability Reporting Directive
By PWC, 4th January 2023.