Governance in the Dictionary means: “to Govern.”  The Dictionary term for Govern is: “to direct the actions and behaviors of others.”  With the stories of Enron and others relating to bad governance and Sarbanes Oxley impacting public companies, what should an ESOP company board do with potential liabilities involving the DOL?   My answer is: “if you have a functioning board including committees, composed of at least one independent director with deep experience in board governance… probably nothing.”   However, if you don’t have this, are you really taking advantage of the best practices that enable ESOP companies to exceed where other companies fail?  Governance is NOT a legal issue for an ESOP company, it is an Ownership issue. 

Governance isn’t all about boards of directors either.  There are Trustees who elect the board members on behalf of the trust beneficiaries, namely the employees.  If you are a stockholder, who is a senior executive of the company, and sits on the board, you are exposing yourself to a nasty surprise if something goes wrong.  The DOL will be looking very closely at conflicts of interest in any governance areas.  Therefore, I suggest there should be a governance committee formed to identify and resolve those conflicts, identify candidates for directorship, establish a board charter and to develop a director orientation process to educate and enable a good directors to perform sooner than later.

Let’s talk about what are some of the best practices an ESOP company could do to make their governance improve company performance.  I am mindful that owners of companies, who desire to use the 1042 rollover, want to enable a succession or estate plan that recognizes the employees who have helped develop their value.  So what is the succession plan?  The Trustees will elect people to a board with an expectation that succession plan will be developed, and that the company will not fold if the owner or founder “suddenly disappears.” 

Succession is not just about picking the next CEO.  How deep is the management team in being effective managers?  A founder reached success by managing risk; so, who is ready to do that if he/she leaves or retires?  Do the middle managers understand their career paths to grow with the company?  I believe this is the NUMBER ONE responsibility for a board to deal with.  Just think back to the basics.  If you were sitting on a board with an EXCELLENT management team, deep with effective managers, should you be concerned with day to day operations?  Should you be seeing a lack of financial performance or major surprises that could have been avoided?  Probably NOT. Having a GREAT succession plan allows boards to focus on the important stuff like: what are the key items that are holding the company back from growing profitably?  Where are the new markets the company should be moving towards?  What new investments should be made to improve sales and profitability?  How can their wisdom improve performance?

When identifying or selecting possible Management candidates, there is always the issue of compensation for that or those individuals.  Therefore, a board should have a compensation committee reviewing the key people, as they may have to select one of them to be CEO someday.  A compensation committee would also review benefits structure and costs.   Obviously, other forms of rewards would also be under their purview.  This committee is not the H/R function of the company, but the policy maker.

One other important committee is the Finance or Audit committee.  Unlike publicly held companies, ESOP boards aren’t required to have financial experts as chairs of the committees.  I do suggest that at least one member have some financial experience beyond the CFO as there may be times when that will be needed.  Areas this committee could be looking into are reporting, banking, the annual report and valuation, as well as management letters by the CPA, budgeting, forecasts, and investment/capital expenditure opportunities.

Boards usually meet quarterly, to review progress from previous presentations from the management team.  As agenda’s are fairly tight, there are several key items to cover as a theme for the meeting.  In the spring, it should be the annual results and valuation, the summer board meeting should cover the company’s strategy and strategic plan, the fall meeting should cover compensation and future investments based on changes to the strategic plan, and the winter should be budgets, forecasts the management team developed.  Committees should meet more frequently to cover details more closely.

Finally, one of the things I learned years ago was that great boards “don’t touch, they sniff.”  That means if they must “touch” or manage the management team, they have the wrong people managing the company.  “Sniffing” represents the desire to learn, to stick your head close to the issue, but not managing it.  Why?  Great boards want their managers to learn from their experience, not to be managed by it.  Great boards have great managers because the directors are engaged with the managers in open discussion with challenges. Directors are great mentors for senior management. Management must drive change, and use the board’s experience to avoid the typical mistakes that companies make without effective boards.  Senior managers must develop middle management to ensure continuity and predictable performance.  Resistance is usually found in middle management, and thus good managers know how to correct resistance, so that change can occur. 

The reason Governance is an Ownership issue, is that you now realize that everyone, from the employee to the trustee and all in between, needs to be on the same page, working together with common goals and pursuits. Each person has a role, and the lack of using their roles effectively creates dysfunction and non performance.  Accountability is inherent within a Governance process, therefore, people must act their roles, and develop great communication systems and skills.  Good Governance creates function and form that allow people to perform as expected and with success.  This is not “touchy-feely” stuff.  It is the concrete foundation a company needs to weather various storms.