Governance best practices in public markets

For private companies approaching the public markets, we believe there are key corporate governance practices that can help pave a path to strong relationships with public market investors. In our view, evolving regulations and market expectations make these factors increasingly important to both company valuations and access to capital. Building a company to this stage requires an incredible amount of hard work and innovation. As private companies begin this transition, we hope our insights as public investors can help make it as easy as possible for them to adapt to rising governance requirements so they can remain focused on growing their businesses.

Here, we share our views on public market governance best practices for shareholder rights, board composition, and executive compensation, in particular.

Shareholder rights

Shareholder rights are significant inputs into the analysis of a company’s governance. We encourage portfolio companies to make progress toward adopting the below best practices over time. We typically choose to engage on these topics rather than vote against the board, but rising market expectations signal increasing votes against directors for these issues.

• Voting power. We believe voting power should be equal to shareholders’ economic stake, with one vote per share as the appropriate standard. However, we understand that some founders want to maintain control during the pivotal early years of being public. Where multiple-class share structures exist, we encourage a vote-to-share ratio of no more than 10:1 and a time-based sunset provision to convert shares over time, preferably less than seven years. We also prefer a majority voting standard for amending bylaws or approving proposals. 
• Annual election of directors and compensation plan. We believe that shareholders’ ability to elect directors and assess how executives are being paid are two of the most important shareholder rights. Allowing for an annual election of directors and approval of the executive compensation plans increases accountability. We believe companies that maintain a staggered board and/or less-than-annual Say-On-Pay frequency should adopt a time-based sunset provision, ideally phasing out the practice(s) over a period of no greater than three years.
• Election of directors by a majority of shareholder votes cast. In our view, the election of directors by a majority of votes cast is the appropriate standard, and governance is less favorable where plurality voting standards are in place. 
• Receptivity to shareholder feedback. We view it negatively when directors appear to disregard shareholder feedback through the voting process, such as failure to implement shareholder proposals that have received majority support, reelection of directors receiving less than a majority of votes, or adoption of poison pills without shareholder approval.

Board composition

In our view, businesses create shareholder value by appointing directors who foster healthy debate in the boardroom, develop constructive relationships with management, and bring an array of relevant skills and experience. This requires boards to elect highly qualified directors who contribute insights from a broad range of perspectives. We understand board composition is a complex topic and use the below considerations as a starting place in our analysis.

• Diversity of thought and experience in the boardroom. While we cannot know the variety of views each director currently brings to the boardroom, we generally believe no board should be comprised of directors from a single industry, skill set, gender, or ethnicity. We encourage companies to disclose the diverse attributes of their board and communicate their strategies and goals for fostering a diverse board. Where we feel a company board lacks diversity, we may choose to vote against the chair or a member of the committee responsible for nominations. 
• Independent oversight. Independent voices in the boardroom are necessary to ensure appropriate management oversight. In our view, two-thirds of directors should be independent at US companies. We favor separate CEO and chair roles and an independent chair as the preferred structure for board leadership to help ensure objective evaluation and compensation of top management. We believe key committees, especially the chairs, should be independent, and may vote against nominating committee chairs or members where we feel independent oversight is lacking. Failing the presence of an independent chair, we think a strong lead independent director is imperative. 
• Director engagement and commitments. Directors represent us as shareholders, and we may vote against any director who risks being insufficiently engaged with their board-related responsibilities. This tends to manifest as:
  • Insufficient engagement — Directors who fail to attend at least 75% of meetings, or
  • “Overboarding” — Director overcommitment, which we define as any executive who sits on more than three public company boards (including their own), or a nonexecutive who sits on five or more public company boards. More recently, we’ve been considering the chair of the audit and remuneration committees as an additional full-time board seat when evaluating if a director is overboarded.

Executive compensation

Management incentives are a key element in long-term value creation and play a vital role in strategy setting, decision making, and risk management. While design and structure vary widely, we believe effective compensation plans attract and retain high-caliber executives, foster a culture of performance and accountability, and align management’s interests with those of long-term shareholders. Due to each firm’s unique circumstances, we evaluate plans on a case-by-case basis. At a high level, we look for: alignment of pay-and-performance evaluated as pay versus annualized total shareholder return over a three- to five-year period; transparency of metrics, targets, time frames and use of discretion; and a balanced mix of awards, preferably closely tied to long-term performance with a significant percentage of compensation at risk.

• Executive pay. We generally ask ourselves three key questions:
  1. Is executive compensation aligned with company performance?
  2. Is executive compensation reasonable considering the company’s size, industry, and circumstances?
  3. Does the compensation plan incentivize appropriate behavior?

• (Nonexecutive) director pay. We review both how and how much board directors are paid. We favor the use of an annual retainer or fee, delivered as cash, equity, or a combination (as opposed to performance-based pay that might pose a potential conflict of interest).
  

Bottom line

Strong corporate governance is critical to every business but can specifically help a private company better prepare for the transition from private to public markets. While “good” governance is not universally defined, we believe that companies that begin to incorporate these broadly applicable best practices earlier on in their life cycles are better positioned for long-term success. Along this governance journey, we think transparency is crucial to building trust with shareholders. As our portfolio companies consider their next steps and governance evolution, we are happy to share our experience and perspective as public market investors to serve as a resource and partner.