EY Center for Board Matters Board Matters Quarterly. September 2018

Transcription

1 EY Center for Board Matters Board Matters Quarterly September 2018

2 2 Board Matters Quarterly September 2018

3 September 2018 Board Matters Quarterly In this issue 04 Crossing the digital divide Companies are increasingly incorporating digital activity into their business models and seeking ways to monetize their digital assets, but there is uncertainty about the tax implications of this activity. Find out what boards need to consider when they oversee tax strategy and risks in the digital age. 09 Audit committee reporting to shareholders in 2018 Our review of proxy statement disclosures by Fortune 100 companies shows that companies continue to increase their voluntary audit-related disclosures. Find out how disclosures have changed since proxy season review An analysis of this year s proxy season reveals several corporate governance trends such as more enhanced disclosures around board composition, increased support for environmental and social shareholder proposals and more information about how companies are engaging with shareholders. 20 A fresh look at board committees Even as boards face increasingly complex challenges in overseeing corporate culture, strategy and risk, we found that board committee structures have not changed since Board Matters Quarterly September

4 Crossing the digital divide What boards need to know about proposed digital tax policies Companies are increasingly incorporating digital activity into their business models. As one of the latest frontiers of competitive advantage, technology innovation is seen as a differentiator across all sectors of the economy. Whether a company manufactures cars, provides asset management services, is a retailer or is in the energy business, chances are that it is exploring some sort of digital strategy. From the buying and selling of products and information to cloud-based data warehousing, businesses are using digital information in ways that were, until recently, the purview of technology companies. The internet and the blurring of industry boundaries resulting from technological innovation mean that many companies are starting to view themselves as technology companies with accompanying digital tax issues. The focus on digital tax policies has evolved quickly, mirroring the rapid integration of digital into the business landscape. Businesses are increasingly discovering ways to monetize their digital assets. Tax policymakers are trying to keep pace with this growing trend, with some countries and supranational groups exploring different digital taxation models. A current lack of agreement on how to proceed, however, threatens to create a confusing tax landscape, with a patchwork of different proposals for businesses to navigate. The end result could be double taxation, distortion of business decisions, a lack of clarity about which types of businesses are affected and potentially increased costs for multinational companies. Increasingly, a company s tax strategy needs to support its digital ambitions while also protecting the investment from tax uncertainty. Digital discord conflicting perspectives While digital taxation is shaping up to be a defining tax issue for 2018, the future state is still ill-defined. The European Commission (the Commission or the EC) and the Organisation for Economic Co-operation and Development (the OECD) are currently on different paths and even within Europe, there are divergent views. Meanwhile, individual countries, driven by political and revenue considerations, have started to move ahead unilaterally. 4 Board Matters Quarterly September 2018

5 At the heart of the debate is a belief by some countries that there is a mismatch between where profits are currently taxed and where and how certain digital activities create value. Three issues at the heart of the digital debate Scale without mass The ability to have a significant economic presence in a country without a major physical presence. User participation and the value of data Many newer business models include elements of data, user participation, user-generated content and network effects. Reliance on intellectual property Particularly heavy reliance on intangible assets, including intellectual property. At the heart of the debate is a belief by some countries that there is a mismatch between where profits are currently taxed and where and how certain digital activities create value. The Commission believes the mismatch is the result of a combination of several factors: first, that businesses can supply digital services where they are not physically established (which they call scale without mass ); second, that digital business models tend to have a heavy reliance on intellectual property assets and are therefore highly mobile; and third, that the business value comes from users participation in the digital activities that some platforms enable commonly described as user value creation. To combat this perceived mismatch, the Commission in late March released two digital tax proposals that, if enacted in their current state, could significantly increase tax costs for many businesses around the world. The first proposal would be an interim 3% digital services tax on gross revenues (i.e., turnover) derived from activities in which users play a major role in value creation. The tax would apply to revenue from activities such as selling online advertising space; digital intermediary activities (i.e., platforms ) that allow users to interact with each other and that facilitate the sale of goods and services between them; and the sale of data generated from user-provided information. Companies with total annual worldwide revenues of 750 million or more and annual EU taxable revenues of 50 million or more would be subject to the tax. Certain types of companies such as digital advertisers and platforms designed to allow users to connect with one another and trade in goods and services would be within the scope of the tax as currently proposed, while others, such as online marketplaces without user-to-user selling, would be outside the scope. But the tax status of many other types of companies is far less clear. For example, many companies may sell information about their consumers to other companies (such as market researchers), but only a portion of the data may be from digital sources as defined by the Commission. It s also unclear whether background data analytics and data transmission to and from the cloud by businesses offering software as a service are included in scope. The Commission s second, longer-term proposal is broader, with more than 50 different digital activities subject to tax. A significant digital presence (SDP) concept would create a new digital permanent establishment (PE) concept, intended to establish a taxable nexus, along with revised profit allocation rules to determine the share of digital profits subject to tax. A company would be considered to have a significant digital presence, and therefore a PE (and pay the headline corporate income tax rate in the EU Member State), if the entity meets any one of three criteria: It exceeds 7 million in annual revenues from digital services in the EU Member State It has more than 100,000 users who access its digital services in the Member State in a tax year It enters into more than 3,000 business contracts for digital services in the Member State in a tax year Board Matters Quarterly September

6 The longer-term proposal mirrors ongoing conversations at the OECD and would dramatically change the way cross-border tax norms operate today. If enacted, it would require tax treaties to be renegotiated between countries. That scenario could result in two different tax systems: one for the EU and one for the rest of the world. As drafted, both proposals would go into effect 1 January 2020, although in reality, the timing of both remains unclear. To be implemented, each of the Commission s digital tax proposals would need to gain unanimous support among EU Members. Individual countries political and economic concerns may make this challenging, especially for the interim proposal, which some Member States fear might negatively affect their key industries and trade relationships. There is a possibility that the enhanced cooperation measure of the EU seldom used could be used if nine or more Member States wish to take the proposal forward. 1 If either scenario fails to play out, an alternative outcome is that a number of EU Member States will simply move forward, unilaterally, with their own digital tax measures. OECD agree to disagree The OECD, which initiated and has led the digital tax debate in connection with its ongoing Base Erosion and Profit Shifting (BEPS) Project, issued an interim report on the tax challenges of digitalization just a few days before the Commission issued its proposals. In its report, the OECD concluded that there is no consensus on the merits of an interim tax such as the one the EC proposes. Unlike the Commission s approach, the OECD report eschewed specific recommendations. Instead, the OECD analyzed the issues and complexities involved and affirmed the goal of producing a final report in 2020 and an update on the issue to the G20 in Some EU Member States have also expressed their preference to wait for the OECD s long-term solution, further complicating the situation. US stance The United States has stated on record that it is opposed to tax policies and proposals that single out digital companies. 2 In fact, some of the resistance to the Commission s interim proposal within the EU appears to be based on concerns about US retaliation at a time when trade tensions are particularly high. Several organizations representing the business community have also raised a variety of concerns about the digital tax proposals. 3 Some business groups have called for greater stakeholder involvement and an emphasis on broader economic impact and job creation. The US is also home to another key digital tax development that will impact US and rest-of-world companies alike. On 21 June 2018, the US Supreme Court (the Court) issued its 6 Board Matters Quarterly September 2018

7 Boards should begin discussing their companies existing digital activity and pipeline projects in new ways, and bring tax into the conversation. much anticipated ruling in South Dakota v. Wayfair. In a 5-4 ruling, a majority of the Court voted to overturn both the Quill and National Bellas Hess cases constituting over 50 years of precedent, finding that the physical presence nexus standard articulated in the two earlier opinions is [an] unsound and incorrect interpretation of the Court s dormant Commerce Clause jurisprudence. Importantly, the decision may be even more far-reaching, as none of the justices appeared to continue to support the old bright-line, court-mandated physical presence standard. It is widely believed that as a result of the Court s decision, states may now begin requiring all remote sellers (i.e., sellers such as those operating in the digital marketplace that do not maintain a place of business in a state) to register, collect and remit sales and use taxes on transactions with in-state customers regardless of the seller s physical presence provided they do so in a manner that does not otherwise violate the US Constitution by discriminating against or imposing undue burdens on interstate commerce. The ruling is likely to significantly impact companies outside of the US that sell goods or provide services directly to US customers (or via their US distributors). These businesses may be required to collect and remit sales tax in US states, depending on how each individual state responds to the Court s ruling in Wayfair. Non-US companies should be aware that the states generally believe that the US international tax treaties do not apply to them and thus, the permanent establishment provisions of those treaties offer non-us companies no protections (other than against discriminatory treatment). As such, non-us companies will be subject to the same economic nexus standards that apply to US domestic companies. Although enforcement by the states against non-us companies that do not have any contacts with the US may be problematic in the short term, if a state determines there was a tax collection responsibility and the non-us company failed to comply, since the non-us company did not file a return, the statute of limitations for assessment and enforcement will remain open indefinitely. Conclusion Many factors, including politics and economic interest, are shaping the current digital tax debate. While the details are still evolving, the likelihood is that new taxes on digital activity will soon need to be factored into businesses strategic plans. Boards therefore should begin discussing their companies existing digital activity and pipeline projects in new ways, and bring tax into the conversation. The effort will require knowledge of the digital tax approach of countries in which they do business, and committing resources to measuring Board Matters Quarterly September

8 Investors need to know about tax risks related to digital activities that may reduce profits if these taxes go into effect. and addressing any resulting tax risks. These risks need to be weighed against the company s digital goals to determine whether tactics, strategy, structures or business models may need modifying. Digital tax issues may also need to be incorporated into investor communications. Investors need to know about tax risks related to digital activities that may reduce profits if these taxes go into effect. They should be informed about the possibility and potential impact of restructuring parts of a digital strategy and the potential need to exit lines of business or markets depending on how tax proposals advance. While the complex issues of how to tax digital activity are not likely to be resolved anytime soon, the debate has implications for all businesses that have digital assets. As such, boards will want to monitor the discussion and become familiar with and conversant in digital tax issues. Questions for the board to consider What level of visibility does the board have into the company s current and future digital activities? Has management been following and appropriately updating the board on recent regulatory developments relating to the taxation of digitalized activity? Has the company modeled different scenarios related to its digital activity and considered the potential tax implications of recent regulatory developments? How is this information communicated to the board? Are disclosures and related risk factors in the company s public filings updated and appropriate given the company s planned digital activity and recent regulatory tax developments? Endnotes 1 This measure would not bind the remaining Member States. 2 Statement of US Treasury Secretary Steven Mnuchin, 16 March 2018, 3 Business and Industry Advisory Committee (BIAC) of the OECD Taxation and Fiscal Policy Committee Activity update, April 2018, p. 4-5, org/wp-content/uploads/2018/04/biac-tax-committee-activity-update-april pdf; BIAC media release, Business reinforces call for multi-lateral effort to address the tax challenges of the digitalizing economy, 21 March 2018, The American Chamber of Commerce to the European Union, an organization representing the interests of American businesses in Europe, has argued that proposals such as the Commission s interim digital tax hinder economic growth and do not align with broadly accepted e-commerce tax principles of neutrality, efficiency, certainty and simplicity. See draft position paper circulated to members, AmCham EU s position on Digital Tax, 20 April Board Matters Quarterly September 2018

9 Audit committee reporting to shareholders in 2018 The EY Center for Board Matters has reviewed voluntary proxy statement disclosures by Fortune 100 companies relating to audit committees and the audit since We examine and track these disclosures because of their value in informing investors about the important role that audit committees play in investor protection through their independent oversight of the external audit. This oversight, in turn, enhances investor confidence in financial reporting. Proxy disclosures in 2018 continue to show a year-over-year trend of increasing voluntary audit-related disclosures. Understanding the context The Sarbanes-Oxley Act of 2002 created a strong regulatory framework to protect the integrity of financial reporting. One of the primary ways the Act accomplished this was by requiring listed companies to have fully independent audit committees that are responsible for the appointment, compensation and oversight of the external auditor. U.S. Securities and Exchange Commission (SEC) regulations do not require disclosure regarding the full range of an audit committee s activities, which means that company disclosures often do not provide investors and other stakeholders with a full picture of this important work. In recent years, investor groups and regulators have encouraged more audit-related disclosure to address this gap. Companies in response have been voluntarily augmenting the information they provide in their annual proxy statements. What we see in 2018 Although the change in percentage of companies providing these voluntary disclosures is smaller in 2018 than in recent years, there has been a dramatic increase in disclosures in most categories since we began examining these disclosures in For example: In 2018, 71% of companies disclosed the length of auditor tenure. In 2017, the percentage was 64%, and in 2012 it was 25%. Sixty-two percent of companies disclosed the factors used in the audit committee s assessment of the external auditor qualifications and work quality, while in 2017 and 2012 the percentage was 58% and 18%, respectively. In 2018, the percentage of companies disclosing that the audit committee considers non-audit fees and services when assessing auditor independence increased to 89% from 86% in In 2012, 12% of companies disclosed this information. Board Matters Quarterly September

10 New auditor disclosure requirements could impact decisions regarding voluntary audit committee disclosures over the next several years. Trends in audit committee disclosures Category Disclosures in the audit committee report Topic Statement that the audit committee is independent Name of the audit firm is included in the audit committee report Audit committee composition Audit committee with one financial expert (FE) Audit committee with two FEs Audit committee with three or more FEs The percentage of companies providing an explanation for a change in all fees paid to the external auditor decreased slightly from 45% in 2017 to 44% in 2018, while just 10% of companies made these disclosures in However, in 2018 only 16% provide an explanation for a change in the audit fee itself. In the table to the right, we provide further data on these disclosures by Fortune 100 companies. Outlook on disclosure requirements Looking ahead, new auditor disclosure requirements could impact decisions regarding voluntary audit committee disclosures over the next several years, including: Required disclosures by auditors have increased: In 2016 and 2017, the US Public Company Accounting Oversight Board (PCAOB) issued rules to expand certain disclosures by the auditor. This could encourage companies to expand their disclosures. These new auditor disclosures include: Lead audit partner s name 1 Identification of the names and locations of other accounting firms that participate in an audit, as well as the extent of their participation 2 Length of auditor tenure 3 More auditor disclosures are on the way: The PCAOB also issued a rule to require disclosure of critical audit matters (CAMs) starting in 2019 for some issuers. CAMs are matters communicated or required to be communicated to the audit committee that relate to material accounts or disclosures and involve especially challenging, subjective or complex auditor judgment. 4 Companies may choose to review their disclosures to make certain the same topics are covered as well. Audit committee responsibilities re: external auditor Identification of topics discussed Fees paid to the external auditor Assessment of the external auditor Tenure of the external auditor Accessibility of audit committee charters from proxy statements (link in proxy statement goes directly to) Explicit statement that the audit committee is responsible for appointment, compensation and oversight of external auditor Topics discussed by the audit committee and external auditor Statement that the audit committee considers non-audit fees/services when assessing auditor independence Statement that the audit committee is responsible for fee negotiations Explanation provided for change in fees paid to external auditor Explanation provided for change in audit fees paid to external auditor Disclosure of factors used in the audit committee's assessment of the external auditor qualifications and work quality Statement that audit committee involved in lead partner selection Disclosure of the year the lead audit partner was appointed Statement that choice of external auditor is in best interest of company and/or shareholders Disclosure of the length of the external auditor tenure Statement that the audit committee considers the impact of changing auditors when assessing whether to retain the current external auditor Audit committee and/or all committee charters Company main website Company site for investor relations Company site for corporate governance 10 Board Matters Quarterly September 2018

11 % 67% 61% 61% 57% 53% 56% 79% 75% 73% 72% 72% 73% 73% 14% 17% 28% 27% 32% 29% 31% 33% 29% 16% 21% 24% 45% 32% 53% 53% 56% 52% 44% 25% 37% 88% 88% 82% 81% 68% 56% 44% 4% 4% 4% 5% 5% 5% 5% 89% 86% 84% 79% 75% 75% 12% Disclosure observations and sample language from Fortune 100 proxy statements Topics discussed by the audit committee and external auditor Reviewed companies indicated that the audit committee raised certain topics with their external auditors other than those required by regulations. Sample language The Audit Committee met in private sessions as required by its charter with representatives of Audit Firm and members of the Company s management, including the Chief Executive Officer, the Chief Financial Officer, the Controller, the Chief Accounting Officer, the Chief Legal Officer and the Vice President Corporate Audit. The Audit Committee and other attendees discussed and reviewed the following, among other matters: Company SEC filings; information technology matters; the scope, resources and work of the internal audit function; the financial reporting process; the consolidated financial statements and related notes; the scope and progress of testing of the Company s internal control over financial reporting; management s assessment of the effectiveness of the Company s internal control over financial reporting; enterprise risk management (ERM); legal and regulatory matters; accounting standards; accounting and controls related to specific company functions, strategic investments, subsidiaries and accounts; and tax matters. 37% 34% 29% 26% 16% 8% 1% 44% 45% 37% 25% 21% 15% 10% 16% 19% 15% 10% 12% 10% 7% 62% 58% 48% 41% 33% 22% 18% 78% 75% 70% 66% 48% 15% 0% Explanation provided for change in fees paid to external auditor Most companies provide an explanation for the types of services included within each fee category. Reviewed companies explained the circumstances for the change. Sample language The decrease in audit fees in 2017 as compared to 2016 is attributable to the fact that Operating Entity is no longer part of the Company and therefore services related to that entity are no longer included. Disclosure of factors used in the audit committee's assessment of the external auditor qualifications and work quality Reviewed companies provided examples of criteria used in auditor assessments. 16% 16% 12% 11% 7% 3% 3% 74% 73% 73% 64% 48% 23% 4% 71% 64% 63% 62% 53% 30% 25% Sample language The Committee annually reviews Audit Firm s performance and independence in deciding whether to retain the Audit Firm or engage a different independent registered public accounting firm. In the course of these reviews, the Committee considers, among other things, the quality and efficiency of the Audit Firm s historical and recent audit plans and performance on the Company s audit; the Audit Firm s capability and expertise in handling the breadth and complexity of the Company s worldwide operations. 63% 60% 53% 49% 33% 16% 3% 12% 12% 12% 16% 16% 11% 8% 38% 38% 36% 38% 40% 41% 44% 25% 25% 25% 25% 27% 27% 26% 25% 25% 27% 21% 16% 21% 22% Notes: Percentages based on total disclosures for audit committees each year. Data based on the 73 companies on the 2018 Fortune 100 list that filed proxy statements each year during and held annual meetings through 15 August Statement that the audit committee considers the impact of changing auditors when assessing whether to retain the current external auditor Reviewed companies indicated that the audit committee considered alternatives to retaining the external auditor. Sample language The Audit Committee also considers whether, in order to assure continuing auditor independence, there should be regular rotation of the independent registered public accounting firm, which includes consideration of the advisability and potential impact of selecting a different independent public accounting firm. The Committee engages in an annual evaluation of the independent public accounting firm s qualifications, assessing the firm s quality of service, the firm s sufficiency of resources, the quality of the communication and interaction with the firm, and the firm s independence, objectivity and professional skepticism. The Committee also considers the advisability and potential impact of selecting a different independent public accounting firm. Board Matters Quarterly September

12 Meaningful disclosure about what audit committees do and how they oversee auditors would provide a window into the important work audit committees perform. How we see it A US survey of investors indicates high degrees of confidence in the audited financial information disclosed by public companies. 5 This confidence aligns with improvements in the quality of financial reporting: in 2017, the number of financial restatements was lower than it has been in 17 years. 6 Yet, at the same time, there was a slight increase in average votes against ratifying the external auditor in the 2018 proxy season. This increase suggests that some investors are taking a stricter approach to reviewing the company-auditor relationship. This could encourage companies to provide additional disclosure around the audit committee s selection of an auditor. Enhancing audit committee transparency can increase investors confidence in financial reporting and their confidence in the role of the audit committee in overseeing the audit process and promoting audit quality in the interest of investors. Meaningful disclosure about what audit committees do and how they oversee auditors would provide a window into the important work audit committees perform, as well as the processes in place to protect auditor independence and professional skepticism and further the alignment among auditors, audit committees and investors. Questions for audit committees to consider How do director qualifications and board composition-related disclosures highlight the expertise, experiences and backgrounds of audit committee members? How has the role of the audit committee evolved in recent years (e.g., oversight of enterprise risk management, cybersecurity risk) and to what extent are these changes being communicated to stakeholders via the proxy statement? What impact will new auditor disclosure requirements have on audit committee disclosures? What additional voluntary disclosures might be useful to shareholders related to the audit committee's time spent on certain activities, such as company restructuring or financial statement reporting developments? Endnotes 1 PCAOB standard, Improving the Transparency of Audits: Rules to Require Disclosure of Certain Audit Participants on a New Form and Related Amendments to Auditing Standards, 15 December 2015, PCAOB website, accessed August Ibid. 3 PCAOB standard, Auditing Standards on the Auditor's Report and the Auditor's Responsibilities Regarding Other Information and Related Amendments, 1 June 2017, PCAOB website, accessed August Ibid. Disclosure of CAMs must be provided in auditor reports relating to audits of large accelerated filers for financial reporting periods ending on or after 30 June For other public companies, this disclosure will be required for financial reporting periods ending on or after 15 December Center for Audit Quality Main Street Survey, 25 October 2017, CAQ website, accessed August Audit Analytics 2017 Financial Restatements A 17-year comparison, May 2018, available through Audit Analytics. 12 Board Matters Quarterly September 2018

13 2018 proxy season review This proxy season, we are seeing enhanced disclosure around board composition, gains in board gender diversity and more companies disclosing investor engagement. These changes reflect shared goals between companies and institutional investors around the benefits of having a diverse board aligned to corporate strategy and key risks. At the same time, more investors are using proxy votes to amplify the call for more women on boards and to support increased transparency and accountability on environmental and social issues. Overall, investor support remains high more than 90% average support for director elections and executive compensation programs across various sectors and market capitalization, despite growing scrutiny of executive compensation and board composition across many dimensions. This report provides five key takeaways for boards as they reflect on this proxy season and evolving governance developments. 1 More than 90% average support for director elections and executive compensation programs Five key board takeaways 1. More companies voluntarily enhance board composition disclosures Today s largest companies are enhancing their proxy statements to give investors clearer insights to the diversity of expertise represented on the board and how those qualifications align with the company s strategy and risk oversight needs. They are also using graphics to highlight other kinds of diversity included on the board, such as diversity of tenure, gender, race, age and nationality. Skills matrix disclosures climb sharply This year close to half of S&P 500 companies disclosed a board skills matrix in their proxy, which is more than four times the 11% that did so in While companies are required to disclose director qualifications, 2 these graphic snapshots have evolved as a voluntary disclosure tool that enhances readability and visually highlights the board s strengths. They highlight board diversity across skills, backgrounds and areas of expertise, in many cases mapping such skills to individual directors. The most successful of these explain how the skill categories connect to the company s strategy and risk oversight needs and clearly align with the information provided in the director biographies. Board skills matrix disclosures S&P 500 companies % 17% % 10% 27% % 6% 20% 1% % 11% Non-director-specific Links skills to specific directors 46% Board Matters Quarterly September

14 Graphics highlighting diversity now commonplace More than half (56%) of S&P 500 company proxies used graphics this year to visually highlight different aspects of board diversity, up from just 20% three years ago. The most common aspect highlighted is tenure, followed by gender, race/ethnicity and age. Director diversity by race/ethnicity remains difficult to track with limited and varying approaches to voluntary disclosure. Top 10 director qualifications highlighted in S&P skills matrices % directorships Corporate finance or accounting (68%) Industry or related industry (55%) International or global (51%) Board experience or corporate governance (50%) Government, public policy or regulatory (37%) Information technology or technology (34%) Capital markets or M&A (31%) Operations, manufacturing or logistics (30%) Risk (44%) Marketing or sales (30%) Benchmarking director qualifications remains complex Because companies take different approaches to skills matrices, comparisons yield an informative but somewhat limited view. For example, one matrix may highlight only directors with deep expertise (though additional directors may have relevant experience), while another matrix may represent that all directors have every skill and experience listed. Additionally, companies may change their disclosure approach over time by further narrowing or broadening the skills categories presented. For example, we looked at the 114 S&P 500 companies that provided a skills matrix in both 2018 and 2017 and observed a significant increase in the percentage of directorships associated with expertise in risk, strategy, board experience/corporate governance and government/ public policy/regulatory matters. Upon closer review, we found that the changes appear to be driven in part by changes in disclosure (e.g., companies adding a new skills matrix category for risk or strategy in 2018) as opposed to new directors bringing new skills to the boards. Skill categories created by EY based on common skill matrix categories. Key board takeaway Disclosure of a well-developed, company-specific skills matrix may help convey to stakeholders how board composition is aligned with the company s unique circumstances, strategy and risk. Using graphics to highlight key aspects of the board s diversity particularly those aspects that are not otherwise discernable (e.g., ethnicity or race) may help demonstrate that the board values and considers such diversity when making director nominations. 14 Board Matters Quarterly September 2018

15 2. Push for gender diversity advances Investor calls for increased gender diversity on boards have grown more urgent in recent years, with some major institutional investors incorporating gender diversity expectations into their director voting policies. 3 Driving this push is the recognition that a diverse board makes better, more robust decisions and sets the tone at the top for the diverse talent the company seeks to attract. This year two things have become clear: many companies share this goal of bringing more women into the boardroom and are driving change, and a growing number of investors are willing to oppose boards that they perceive as insufficiently diverse. Nearly half of S&P 500 boards now include three or more women S&P 500 boards show a commitment to diversity that goes beyond just checking the box: they continue to add more women to the board. Since 2015, the portion of boards with at least three women has increased by 14 percentage points. More broadly, turning to the S&P 1500, similar gains have been made. The portion of companies with three or more women on the board has grown from 19% in 2015 to 29% this year. These changes suggest that boards that have experienced diversity recognize the value it brings to board decisionmaking and performance. S&P 500 boards with three or more women increasing Boards with no women Boards with two women Boards with one woman Boards with three or more women % 26% 35% 41% Rate of increase in women-held directorships has accelerated Since 2013, the proportion of women-held directorships at S&P 1500 companies has grown just one percentage point each year a pace that would take more than 30 years to reach gender parity. This year that proportion has already increased by two percentage points, growing from 19% to 21%, with the second half of 2018 still to go. The rate of increase has, finally, accelerated. All-male boards face increasing opposition While director opposition votes typically average 3% to 4%, average votes against all-male boards are significantly higher and rising. Votes against nominating/governance chairs have grown at the very limited number of S&P 500 boards that lack gender diversity. Average director opposition votes at all-male boards S&P 1500 companies Nominating/governance committee chair Remaining directors Nominating/governance committee members % 6% 5.6% 7% 11.2% 15.2% % 12% 38% 49% Board Matters Quarterly September

16 Notably, opposition votes at all-male S&P 1500 boards have more than doubled since 2015, with those chairs receiving an average opposition vote of 15.2% this year vs. just 3.6% for the same role at boards that are 20% female. Similarly, votes against nominating/governance committee members and all other board members at all-male S&P 1500 boards rose to 11.2% and 5.6%, respectively, compared with 3.3% and 2.3%, respectively, for their counterparts at boards comprised 20% of women. Key board takeaway The portion of companies with three or more women on the board is growing, while all-male boards are becoming extinct. This shift along with the increased willingness by investors to vote against boards lacking female directors increases the pressure on boards to diversify. While the spotlight remains on gender for now, boards should also prioritize strengthening other types of diversity. take insufficient action in response, many investors will consider voting against incumbent directors at the next annual meeting. Proposal topics securing majority support so far this year include climate risk, coal-related risks, greenhouse gas emissions, gun safety, the opioid crisis and sustainability reporting. Notably, two of four climate risk proposals voted so far secured majority support, and a third secured 46%, building on the historic majority votes from last year 4 and reinforcing climate risk as a mainstream investor concern. Support for environmental and social proposals by threshold More than 30% support More than 50% support More than 40% support 47% 3. Environmental and social shareholder proposals gain traction At the 106 Russell 3000 companies where shareholder proposals on environmental and social topics came to a vote, these proposals saw a marked increase in support, with a larger portion of these proposals reaching key support thresholds. The percentage of environmental and social proposals securing majority support doubled, with 6% passing the 50% mark, up from 3% or less over the past decade. Similarly, 19% secured at least 40% support, up from 12% last year. And 41% attained at least 30% support, up from 29% last year. 1% 2% 15% 6% Key board takeaway 19% Increasing support for environmental and social shareholder proposals indicates that more mainstream investors may view these topics as material to shareholder value. Withdrawal of these proposals remains common, with close to a third being withdrawn this year. Engagement with proponents may reveal areas of common ground. Reaching these voting thresholds matters. Thirty-percent support is the level at which many boards take note of the proposal topic, and at 50% support, if the board is deemed to 16 Board Matters Quarterly September 2018

17 Dialogue with investors continues to influence changes in company disclosure and practices. 4. Investor engagement continues to grow Since company-investor engagement began to reshape the governance landscape, engagement on governance topics and disclosure of these efforts in the proxy statement continues to grow. So far this year, 77% of S&P 500 companies have disclosed engaging with investors over the previous year, up from 56% in And director involvement in these efforts is also increasing. This year, one-quarter of S&P 500 companies, or one-third of the companies disclosing engagement, said that board members were involved, up from 10% or less than a fifth of companies disclosing engagement in These dialogues with investors continue to influence changes in company disclosure and practices. This year, 45% of the companies that disclosed engagement also disclosed making engagement-related changes (most commonly regarding executive compensation), compared with 46% in S&P 500 companies that disclose investor engagement Director involvement disclosed 10% 16% 25% 21% 46% 49% No director involvement disclosed 49% 52% 56% 65% 70% 77% 5. Say-on-pay gets steady support in wake of pay ratio disclosures With the long-anticipated CEO pay ratio disclosures now in proxy statements and in the press investors continue to show overwhelming support for most executive compensation programs. Overall support for say-on-pay (SOP) proposals continues to hover around 91% across nearly all companies, and the portion of proposals failing to receive 50% support remains at around 2%. Even looking at the 20 companies with the highest pay ratios so far, more than half secured support from 90% or more including three of the companies among the top 5 highest ratios. That pay ratios do not appear to be significantly impacting SOP support is not unexpected, as only a few investors raised the topic with us in our outreach conversations as an area of focus and mainly in the context of talent and human capital management. Instead, a variety of investors reported different approaches regarding pay, with some focused on the rigor of performance incentive structures, others focused on how pay incentives align with strategy and/or sustainability goals, and others looking into how pay aligns with risk culture and pay equity. Given increasing investor attention to human capital management, 5 it is possible that the now-public median pay figures may further inform engagement around how companies are investing in their workforce. Key board takeaway As outreach to and direct engagement with shareholders cements itself as a key feature of the governance landscape, engagement practices and related investor expectations continue to evolve. Companies undertaking engagement should make efforts to anticipate and meet these expectations. Key board takeaway Proactive outreach to investors, enhanced pay disclosures and changes to pay practices in response to shareholder feedback remain key opportunities for securing voting support. Some companies may consider enhanced disclosure around how investing in and compensating the workforce fits into the company s talent agenda. Board Matters Quarterly September

18 Sector insights related to... Director qualifications Based on S&P 500 companies that disclose a skills matrix. Risk oversight Board gender diversity % of female-held directorships Based on S&P 1500 companies. Most expertise Utilities, real estate and financials Least expertise Health care, consumer discretionary and information technology Leaders 28% 28% 27% Strategy Most expertise Industrials and utilities Utilities Consumer staples Consumer discretionary Least expertise Telecommunication services and consumer staples Laggards 13% 16% 17% Corporate social responsibility/sustainability Most expertise Utilities, materials and energy Energy Real estate Information technology Least expertise Telecommunication services, information technology and real estate Key environmental and social shareholder proposal topics Which sectors faced the most shareholder proposals related to... Climate risk Energy and utilities Sustainability reporting Consumer discretionary and consumer staples Workplace diversity Financials, information technology, consumer discretionary Pay inequality Financials and information technology 18 Board Matters Quarterly September 2018

19 Questions for the board to consider Are there opportunities to enhance communication around how directors skills and areas of expertise align with the company s unique oversight needs? Does the proxy statement showcase the board s diversity and disclose diversity goals to help demonstrate the value the board places on diversity? How is the board overseeing environmental and social risk and value drivers, particularly in relation to long-term strategy? And how is the company communicating to investors on these topics? Endnotes 1 Vote results and shareholder proposal data for 2018 are as available for meetings through June. Proxy disclosure data is based on 454 S&P 500 company proxy statements available as of 9 July. All other data is full-year and based on the Russell 3000 index unless otherwise specified. 2 Under proxy statement disclosure enhancement rules effective 28 February 2010, companies are required to disclose the particular experience, qualifications, attributes or skills that led the company s board to conclude that the person should serve as a director of the company. 3 See BlackRock Proxy voting guidelines for U.S. securities, February 2018, and State Street Global Advisors Guidance on Enhancing Gender Diversity on Boards, See our 2017 proxy season review. 5 See our 2018 proxy season preview for more on investor areas of focus. How does the board stay informed about key shareholders engagement priorities and views of the company s governance practices? How do workforce pay practices including pay equity for women and minorities support the company s culture and talent agenda? Board Matters Quarterly September

20 A fresh look at board committees In this age of innovation and transformation, today s board members face increasingly complex challenges in overseeing corporate culture, strategy and risk oversight. The digital revolution has facilitated radical changes in business models and made cybersecurity a strategic business imperative. Intangible assets have become a primary driver of long-term value, making the talent agenda mission-critical. Companies are adapting to changes in the labor market, digitization and automation, and a growing spotlight on corporate values and purpose. And all of this is occurring against a backdrop of rising geopolitical tensions and trade policy challenges. We have tracked board structures since 2013, examining how S&P 500 companies are using board committee structure to address oversight needs. This report is based on a review of the 418 proxy statements filed as of 15 May The same set of companies in 2018 and 2013 were examined to provide consistency in the review. Findings Amid sustained and unprecedented change, board committee structures stayed largely the same over the past six years. Across all industries, boards primarily rely on the three key committees generally required by the stock exchanges audit, compensation, and nominating and governance. 1 Bank holding companies (BHCs) of a certain size, whether public or privately held, are required to also have separate risk committees a fourth key committee so to speak. 2 Above and beyond these committees, institutions typically have one additional standing board committee ( additional committee ) (usually an executive or finance committee). During , the portion of companies with at least one additional committee grew marginally from 74% to 76%, and the average number of additional committees remained largely consistent. The most common committees remained the same. More than one-third of S&P 500 companies had an executive or finance committee. Use of executive committees declined slightly from 38% to 36%, while finance committees held steady at around 36%. Other committees were much less common. 20 Board Matters Quarterly September 2018

21 Companies are adapting to changes in the labor market, digitization and automation, and a growing spotlight on corporate values and purpose. S&P 500 (%) Top additional committees by common responsibilities Top sectors with this committee 36% 36% 16% 11% 7% 7% 6% Executive Exercises authority of the board when the board is not in session, except in cases where action of the entire board is required by charter, bylaws or applicable law Finance Oversees capital allocation, financial policies, strategies, capital structure, and annual operating and capital budget May also oversee investments, dividend policy, credit and other market risks, share repurchases, and mergers and acquisitions Compliance Oversees programs and performance related to legal and regulatory risks, as well as implementation and maintenance of the company s code of conduct and related matters May focus specifically on compliance in a variety of areas, e.g., environmental, health, safety and technology Risk Recommends the articulation and establishment of the company s overall risk tolerance, risk appetite Oversees enterprise-wide risk management to identify, assess and address major risks facing the company, which may include credit, operational, compliance/regulatory, interest, liquidity, investment, funding, market, strategic, reputational, emerging and other risks Reviews and discusses management s assessment of the company s enterprise-wide risk profile Technology Oversees and assesses the company s technology related strategies, makes recommendations regarding the scope, direction, quality and investment levels, and oversees the execution of technology enablement formulated by management Reviews and discusses management s assessment of the company s technology profile Addresses opportunities and risks, including aspects of cybersecurity Public policy and regulatory affairs Reviews significant legal, legislative and regulatory initiatives and rulemaking by federal, state, local and foreign government authorities, as well as other public issues likely to affect the company and its shareholders Oversees the development of company policies in response to these developments and may have a related compliance function Corporate responsibility and sustainability Reviews policies and practices related to specific public issues of concern to shareholders, the company, employees, communities served and the general public, with oversight of corporate responsibility, environmental sustainability, diversity and inclusiveness, and reputational risk Financial (21%) Industrials (17%) Cons. discr. (14%) Cons. discr. (16%) Industrials (16%) Financials (16%) Utilities (25%) Health care (19%) Energy (15%) Financial (74%) Cons. discr. (4%) Industrials (4%) Technology (4%) Utilities (4%) Financial (21%) Health care (18%) Cons. discr. (14%) Industrials (14%) Health care (21%) Energy (18%) Cons. discr. (14%) Utilities (14%) Cons. discr. (38%) Financial (31%) Materials (15%) Note: Committee responsibilities vary by company, and some functions may overlap. Board Matters Quarterly September

22 Ten percent of companies assigned oversight of cybersecurity, digital transformation and information technology to an additional committee. Industry matters. Financial, telecommunications and utilities companies average two or more additional committees. Health care, consumer staples, industrials, consumer discretionary and materials average one to two. Energy, real estate and technology companies average less than one. Few additional committees focus on emerging risk and innovation. Compliance, risk and technology committees grew marginally. In 2018, the overall percentage of S&P 500 companies with these committees remained low at 16%, 11% and 7%, respectively. Other types of committees largely held steady or declined. A variety of additional committees oversee technology matters. Ten percent of companies assigned oversight of cybersecurity, digital transformation and information technology to an additional committee. These were typically technology, risk or compliance committees. A closer look at the big banks Large BHCs are unusual in that they are required to have a board-level risk committee. For these firms, other common additional committees included: Questions for the board to consider Is the board s committee structure appropriate to forward-looking board priorities and company-specific needs? Are the board size and composition adaptable to changing committee responsibilities as needed based on the company s evolving oversight needs? Is the board familiar with how peer companies are addressing board oversight responsibilities? Do assessments of board effectiveness reveal possible pressure points that might be resolved with changes in committee structure? As committees assess their own effectiveness and performance, are their capacity, workload and areas of expertise part of that assessment? As new directors join the board and bring new areas of expertise, does the board consider whether the current committee structure fully leverages those new director skills? 35% executive 35% finance 29% technology 29% corporate responsibility 18% compliance Endnotes 1 Subject to certain exemptions, companies listed on the NYSE or NASDAQ must have independent audit, compensation and nominating/corporate governance committees. As an alternative to a nominating/corporate governance committee, director nominees may be selected by a majority of the independent directors for NASDAQ-listed companies. 2 The Federal Reserve s Enhanced Prudential Standards require separate risk committees for large publicly held US bank holding companies with total consolidated assets of $10 billion or more. 22 Board Matters Quarterly September 2018

23 Better Questions for Boards Webcast series Our series is designed to provide directors with insights and questions to consider as they engage with management on a variety of complex boardroom issues. You can access on-demand replays to hear insightful discussion about how boards are approaching a variety of issues. The board s role in navigating geopolitics Are you gaining a competitive edge with your geostrategy? With political outcomes and the economic environment becoming harder to predict, many organizations see policy uncertainty, rising geopolitical tensions, and changes in trade policy and protectionism as key risks. These developments underscore the need for companies to proactively address strategic opportunities and risks stemming from geopolitical and regulatory changes. Listen to a discussion on how leading companies are navigating geopolitics and the board s role in addressing this challenge. Next-generation enterprise risk management Risk won t wait, will you? Risk hasn t just reached the boardroom door it s pounding to get in! And that s exactly what needs to happen. Boards have to unlock the door and face risk head on. Risks will only continue to grow in complexity, overlapping and impacting business in unprecedented ways. Our panel discussed nextgeneration enterprise risk management (ERM) and shared their perspectives on how companies are addressing it at the board level. Talent agenda Is talent a secret weapon or the biggest challenge for boards? From building a culture of innovation, to defining purpose and maximizing growth opportunities, a successful people strategy is fundamental for long-term value. That s why talent is quickly moving to the top of board priorities. We talked to Peter Fasolo, Executive Vice President and Chief Human Resources Officer at Johnson & Johnson, and others about talent trends and heard their perspectives on how companies are addressing the talent agenda at the board level. Access any of our on-demand webcasts at ey.com/boardmatters. Board Matters Quarterly September