The governance bells are tolling for corporate, non-corporate, not for profit, governmental, and other organizations. Investor and stakeholder demands, regulatory actions, and growing litigation risks are contributing to the focus on management and director responsibilities for effective governance. The personal and political governance evolution supports this increased focus. Therefore, there is a need to stress test governance structures and examine the viability of existing checks and balances, to review the increased focus on board governance and oversight responsibilities, and to explore opportunities to create stronger governance structures, all while continuing to recognize governance’s often pivotal role in litigation.
Stress Testing Governance Structures
Stress testing determines the effectiveness of the organization’s governance structure in addressing the needs of a particular organization at that point in time. Stress testing examines how—and how well—an organization’s management and board are directing current operations and their level of preparedness to react to specific risk and challenges. Those challenges may stem from various sources such as business competition, economic events and conditions, regulatory inquiries, changing shareholder expectations, litigation, or other causes. This is not a middle market situation. The need for effective stress testing is exemplified in high profile cases referred to in earlier Corporate Governance Corner columns: Wells Fargo and Boeing.
This focus on governance structures goes back to, and beyond, the well-known Walt Disney Shareholder Derivative Litigation. Mentioned previously in this column, the Disney Litigation involved the hiring (and subsequent termination) of Michael Ovitz, who received an estimated $130 million termination package after 14 months of disappointing performance. At that time, the Disney Litigation was referred to as the corporate governance case of the century. The court made the board’s responsibilities for governance and oversight clear and, as Delaware Chancery Court Chancellor Chandler said, examined each individual director’s performance. The Disney Litigation was eye-opening to many in the corporate sector because it was previously presumed that the business judgment rule defense would bring a quick end to the litigation. The Delaware Supreme Court did not see it that way and remanded the case to the lower court where the derivative suit would be tried on the merits: the Delaware Chancery Court, where it was heard by the Chancellor (In Re the Walt Disney Company Derivative Litigation, https://courts.delaware.gov/opinions/download.aspx?ID=64510). Ultimately, Disney and its directors prevailed; however, that was not the case in the Wells Fargo litigation, nor Boeing.
Putting the Governance Structure Under the Microscope
Revisiting the division of labor.
A fundamental economic guidepost outlined in Management 101 and Introduction to Organization Behavior courses is that the division of labor is specific to an organization at a point in time. Two organizations, even if controlled by the same parties and appearing identical in many respects, may be organized and operated quite differently.
The belief that organizational and operational issues can be addressed simply by adopting best practices overlooks and neglects the unique governance, oversight, and management issues that an organization can face at any point in time. Boards, board committees, management, and the corporate governance lawyer must work together to address the fundamental responsibilities of governance, oversight, and management. These parties should put their collectively developed approaches to work within the Strategy/Plan/Operate/Control cycle of the organization structure shown in the Exhibit.
EXHIBIT
The Organization Governance Structure
Stress-testing the structure.
Evaluating the governance structure of any organization is complex and situation-specific. Respective responsibilities must be defined, transparency must be ensured as is appropriate, and the necessary checks and balances must be in place and functioning.
These factors are dynamic and must be modified when needed. The board, its committees, management, and its internal and external auditors must develop, implement, and comply with a governance approach that works best within the specifics of the organization’s Strategy/Plan/Operate/Control cycle. This is especially true in order to navigate today’s unpredictable environment—spanning economic headwinds, tariffs, tax planning, geopolitical tensions, technology, and internal workforce dynamics. This is exacerbated by the need to balance long-term vision and the array of today’s complex and interconnected risks that impact real-time decision making that are in the best interest of all stakeholders.
Furthermore, stress testing an organization’s governance structure is not without sensitivities. It may be appropriate to engage a deeply experienced, properly positioned third-party (like the authors’ own firm) who understands these sensitivities to assist in the effort, but it should be done in a compact timeframe.
In an organization, there can be differences of opinion about the organization’s current operations. These differences are healthy and to be expected. Stress testing aids in ensuring these different views and opinions exist and are being considered, and that multiple parties are aware of important tasks to be accomplished and can observe them.
Governance’s Often Pivotal Role in Litigation
Governance issues can occupy a pivotal role in litigation, for both plaintiffs and defendants. The authors have been writing on this topic for over a decade (see “The Interplay Between Corporate Governance Issues and Litigation: What is Corporate Governance and How Does it Affect Litigation?” Business Law Today, December 2016; and “Governance Lessons from the Disney Litigation,” Business Law Today, September 2011), arguing through actual case studies affirms our firm’s belief in the importance of stress testing an entity’s governing structure as part of minimizing litigation. This column has also mentioned before how important governance issues have been in major cases like Wells Fargo and Boeing.
Delaware law is clear: the business and affairs of a corporation are managed by or under the direction of its board of directors. This has been aptly demonstrated in earlier columns, as elucidated by Delaware Chief Justice Norman Veasey (“What Happened in Delaware Corporate Law and Governance from 1992-2004? A Retrospective on Some Key Developments,” University of Pennsylvania Law Review, May 2005) and Delaware Chancery Court Chancellor William B. Chandler, III in his opinion in the aforementioned Disney Litigation. Effective stress testing examines the extent to which an organization is focused on that issue.
