Charting the right course
Board governance for US IPO-bound companies
A successful IPO company can land on an index almost overnight, a move that brings expectations from institutional and large investors. A plan to meet those expectations is key to cultivating investors and analysts — and is important to long-term success in the markets.
As their influence in the boardroom has grown, investors are challenging governance practices. Many companies have made governance changes to demonstrate responsiveness — with larger companies leading.
Specifically, investors seek:
- Independent board leadership
- Annual director elections
- Diversity and independence in board composition
- One share — one vote
We conducted extensive research into governance practices of companies in the Standard & Poor’s 500 index and companies that went public in the US and were included in the Russell 3000 in 2013.
IPO companies generally have some distance to travel before attaining what investors consider governance maturity.
Companies that boast of strong financial performance or solid reputation can enjoy some leeway. The not-so-good news is that financial results and reputations can change quickly. That should give pause to both public companies and those looking to go public soon, because sustaining valuation after the IPO is key.
A call to action
When analysts and investors believe a company is well-run, with accountable and transparent governance, they are more likely to give it the benefit of the doubt during a rough patch.
Investor expectations of corporate governance practices and transparency continue to rise, and our research shows that governance practices are evolving accordingly. To attract maximum long-term investor support, leading IPO-bound companies should develop a plan to incorporate these expectations into their practices.
Independent board leadership
Among S&P 500 companies, independent board leadership — whether in the form of an independent chair or lead director — has grown substantially recently.
In 2002, just 8% of S&P 500 company boards had independent board leadership. In 2013, 71% did — mostly in the form of independent lead directors, who set board meeting agendas, control the flow of information to the board and convene non-management directors.
By contrast, just over half of IPO companies have independent board leadership.
Large companies are moving away from classified boards, in which directors are elected to staggered terms, and from plurality voting in director elections, where a director can be elected with the support of just one vote.
A classified board has traditionally formed part of companies’ defenses against hostile takeovers; today, the value of these measures in terms of takeover avoidance is discounted. Instead, large companies focus on demonstrating greater board accountability to investors.
And investors are now looking at smaller companies to adopt these measures. Given the more concentrated holdings common at newly public companies, these measures are relatively rare.
Among companies in the S&P 500, 87% have annual elections, while 85% have majority voting. Among 2013 IPO companies, 25% had annual elections, and 3% had majority voting.
Companies demonstrating plans regarding director elections and majority voting will likely fare better with investors.
As an IPO company’s strategy shifts, so will its board composition. Investors want to know about the board’s skills and experience, and how directors are positioned to grow, compete and take advantage of market opportunities.
Investors have expressed expectations of gender and ethnic diversity and independence. In a recent survey, the Credit Suisse Research Institute found that companies with women on their boards showed higher than average growth (14% vs. 10%) and a higher return on equity (16% vs. 12%).
Regarding independence, lawmakers and regulators have established minimum thresholds, and most companies have gone further. On most boards today, all but a few directors are independent.
And while controlled companies are not required to have a majority independent board, most do. Eighty-four percent of directors at S&P 500 companies are independent, versus 67% at IPO companies, a number that will rise as IPO companies grow their boards and meet regulatory requirements.
One share, one vote
Most investors believe that each share of a public company’s common stock should have one vote, and that investors’ voting rights should be proportional to their holdings. Experience has taught investors that concentrated voting power in insiders’ hands can lower boards’ accountability and increase governance-related risks.
Companies with dual- or multi-class shares are increasingly being targeted by shareholders. IPO companies, which are two to three times more likely to have dual-class stock than more established companies, are best served by moving away from such structures.
Having a plan to meet investor expectations on governance is a leading practice. Here are simple steps every IPO-bound company should consider:
- Identify the gaps between your company’s practices and investor expectations
- Develop a plan to close the gaps and take action in the short term where prudent and feasible
- Disclose the plan to investors to demonstrate commitment to good governance