The overall effectiveness of corporate governance among publicly traded companies declined slightly in 2021, according to data from the third annual American Corporate Governance Index (ACGI) from the Institute of Internal Auditors and the Neel Corporate Governance Center at the University of Tennessee, Knoxville’s Haslam College of Business.
Managing change and uncertainty is part of doing business, and 2021 proved as great a test in this respect as any in recent years. As the effects of the COVID-19 pandemic linger, the push for better environmental, social, and governance (ESG) disclosures gains steam, and the fallout from two years of business, economic, and social disruption manifests in varied ways, the need for effective governance is clear. Still, data from this year’s ACGI survey of companies traded on U.S. exchanges found governance improvements made in 2020 slowed or stagnated across a number of areas.
Last year, the number of companies receiving top scores dropped from one-in-five to one-in-seven. The average ACGI score for U.S. companies remained at a “B-,” but dropped to 81 on a 100-point scale, down from 82 in 2020.
“Although a decline of one point seems small, it’s out of alignment with the increased scrutiny on companies to improve their governance as they face continued market and regulatory pressures,” said Anthony Pugliese, president and CEO of the Institute of Internal Auditors. “They’re heading in the wrong direction and the solution is already in house. Boards and executive management must remain committed to improving governance across all the areas examined in the ACGI and independent assurance provided by internal audit must be an integral part of those efforts.”
Falling Down on ESG Reporting
Data from the 2021 ACGI survey signaled two critical areas where governance slipped:
- Some companies are not providing adequate employee training or compensating them in a way that promotes ethical decision making.
- Companies are slow to address increased activism related to ESG from a broad range of stakeholders.
“The lack of progress around ESG matters is particularly concerning given the recent formation of the International Sustainability Standards Board (ISSB) to promote a global uniform standard for ESG disclosures as well as the anticipated proposed rules from the Securities and Exchange Commission on climate change reporting,” added Pugliese. “New regulatory reporting rules such as these will require the same level of oversight and governance expected for financial disclosures by the markets and regulators and therefore should be top priorities for boards, audit committees and Chief Audit Executives. An independent internal audit function is absolutely critical to build trust and confidence in ESG information if we expect that information to be useful and actionable by stakeholders.”
Terry L. Neal, director of corporate governance at UT’s Neel Corporate Governance Center said the 2021 ACGI score continues to show that many U.S. companies are falling short of what the center considers strong governance practices. “Particularly interesting to us are some consistent associations that we can now see with three years of ACGI data,” said Neal. “Specifically, companies where CEO-chair duality is accompanied by strong board independence, as well as those where the hiring, firing, and compensation decisions of the head of internal audit reside with the CEO or the audit committee, continue to exhibit higher ACGI scores.”
The ACGI is designed to be a barometer of American corporate governance and goes beyond the publicly observable aspects of corporate governance to provide an internal perspective on the effectiveness of corporate governance throughout the organization. The questions and scenarios were developed based on in-depth interviews with leading CAEs to provide insight into how companies perform in key areas based on Guiding Principles of Corporate Governance, developed in partnership between the Neel Corporate Governance Center and the IIA. 