COSO (Committee of Sponsoring Organizations of the Treadway Commission) has recently released an exposure draft of the Corporate Governance Framework (CGF) and is inviting public comment.
In this article, we review the key themes and important ideas presented in the Public Exposure Draft. The CGF aims to provide comprehensive guidance for entities seeking to enhance governance, risk management, internal control, and fraud detection, ultimately contributing to long-term value creation.
1. Purpose and Scope of the COSO CGF
COSO, a globally recognized private-sector initiative, has developed the CGF to offer a common language and framework for corporate governance. It is "grounded in enduring principles but flexible enough to adapt to each entity’s unique reality." While primarily tailored for US public companies, the CGF is designed to be useful for "non-U.S. public companies, global companies, private companies, and public-sector organizations," and is "agnostic of industry and size of organization."
2. Driving Forces and Evolution of US Corporate Governance
US corporate governance practices are shaped by a baseline of expectations from courts, regulators, investors, and market forces. Key drivers include:
State Corporate Law: Governs formation, operation, and dissolution of corporations, defining legal frameworks, shareholder rights, and fiduciary responsibilities.
Federal Statutory and Regulatory Requirements: Laws like the Sarbanes-Oxley Act and Dodd-Frank Act, often developed in response to corporate failures, focus on specific aspects of governance and financial markets, such as disclosure and compliance obligations for public companies.
Stock Exchange Listing Requirements: Pre-eminent exchanges like NYSE and Nasdaq impose listing standards covering aspects such as "board independence, committee structure, audit and other committee composition, and the adoption of governance guidelines and a code of ethics and conduct."
Market-Based Solutions or Rules: Shareholders, market intermediaries, and proxy advisors can influence the adoption of new governance standards, often led by large-cap corporations.
3. Shift Towards a Multi-Stakeholder Model
Historically, public companies operated under the principle of shareholder primacy. However, the CGF notes a significant shift: "most leaders now understand that delivering long-term shareholder value requires meaningfully considering the interests of other stakeholders as well." This broader perspective, encompassing all stakeholders whose engagement and well-being influence performance, is seen as strengthening rather than diluting shareholder interests.
4. Who Benefits from the CGF?
The CGF is designed to benefit all corporate governance stakeholders:
Boards: Can use the CGF to align governance with "entity’s values, strategy, and long-term objectives," establish tone, reinforce cultural expectations, and assess their effectiveness.
Executive Management: Supported in balancing authority with accountability and transparency, using the CGF to strengthen governance practices and enhance decision-making.
Shareholders: Gain increased visibility into governance practices, enabling them to "develop engagement strategies to determine whether an entity’s approach to corporate governance is aligned with how shareholders expect it to deliver value."
5. Structure of the Corporate Governance Framework
The CGF "reimagines corporate governance as a dynamic and adaptable system rather than a checklist of policies and requirements." It is depicted as a circle, symbolizing its ongoing, iterative nature, with "Long-Term Value" at its core as both the foundation and goal.
Six "essential Components" surround the center, each "equally important and reinforcing one another in support of long-term value creation":
Oversight: Establishing board structure, exercising oversight, appointing leadership and members, selecting the CEO, establishing executive structure, operating the board effectively, and upholding shareholder rights.
Strategy: Defining purpose and core values, developing and communicating strategy, executing strategy, and measuring performance against strategy.
Culture: Establishing and modelling culture and behaviors, promoting ethics, respect, and open communication, and assessing and adapting culture.
People: Deploying people strategy and succession planning, managing people and compensation, and driving performance and development.
Communication: Committing to information quality, engaging stakeholders strategically, communicating effectively with internal stakeholders, and maintaining transparency.
Resilience: Managing and overseeing risks and opportunities, establishing and evaluating internal control, and monitoring governance effectiveness.
At the heart of the CGF are four stakeholder groups: "the board, executive management, shareholders, and other stakeholders," each connected to all six components.
6. Key Principles and Areas of Focus within Components
The CGF details 24 principles across its six components, each supported by "Points of Focus" and "Deeper Insights."
6.1. Oversight (Principles 1-6)
Board Structure and Oversight (Principle 1): Emphasizes defined roles, responsibilities, and committees, with active oversight to support management and maintain accountability. Directors' responsibilities are largely determined by fiduciary duties (care and loyalty), protected by the business judgment rule.
Board Committees: Standard committees include:
Audit, overseeing financial reporting, internal control, and internal audit (IA) independence;
Compensation, developing executive compensation policies aligned with strategic objectives; and
Nominating/Governance, shaping governance guidelines and board composition.
The CGF notes flexibility in committee structures and responsibilities.
Board and Director Attributes (Principles 1 & 2): Highlights the importance of directors engaging in "thoughtful inquiry," demonstrating "professional skepticism," and committing to "continuous learning." A "super-majority of the board is independent," a leading practice promoting objective oversight. Board composition should reflect "a range of experience and expertise aligned with the key opportunities and risks derived from the entity’s strategy," including "cognitive diversity."
CEO Selection and Delegation (Principle 3): The board delegates significant authority to the CEO and executive management, formalizing matters reserved for the board versus those delegated.
Executive Management Structure (Principle 4): The CEO assembles an executive team with necessary skills to execute strategy ethically. Management-level committees support cross-functional collaboration and decision-making.
Board Effectiveness (Principle 5): Emphasizes effective board meetings, timely and accurate board minutes (maintained by a corporate secretary), and adherence to a clear Delegation-of-Authority Policy. Key governance documents include Articles of Incorporation, Bylaws, Corporate Governance Guidelines, and Board and Committee Charters.
Shareholder Rights and Accountability (Principle 6): Upholding shareholder rights through "clear, transparent disclosures," facilitating "meaningful dialogue," and enabling informed voting. Shareholders can influence through proxy voting and direct engagement, with a strong preference for director election by majority vote.
6.2. Strategy (Principles 7-10)
Purpose and Core Values (Principle 7): The board and executive management define a clear, enduring purpose as the "fundamental reason for being," aligning core values to guide decision-making and shape behaviors.
Strategy Development and Communication (Principle 8): Understanding competitive value, assessing the validity of the business model, and communicating relevant parts of the strategic plan internally and externally, tailored to different audiences.
Strategy Execution (Principle 9): Establishing an operating model to support strategy execution, allocating capital and resources, and creating operating plans and budgets aligned with strategic plans. The board approves capital allocation and monitors its implementation.
Performance Measurement and Adjustment (Principle 10): Tracking progress against strategic goals using financial and non-financial KPIs, with board oversight, and adjusting the strategy as necessary.
6.3. People (Principles 14-16)
People Strategy and Planning (Principle 14): Executive management establishes a people strategy aligned with business strategy, including talent planning, diversity, equity, and inclusion, with board oversight. The board also reviews board succession plans (multi-year horizon, 3-5 years).
Managing People and Compensation (Principle 15): Establishing effective compensation structures (including for directors and executives) that align with strategic objectives and shareholder interests, and managing performance effectively.
Driving Performance and Development (Principle 16): The board annually assesses its own performance and, periodically, individual directors. The CEO sets clear goals for executive management, and the entity has established processes for employee performance assessment and development programs, including upskilling/reskilling.
6.4. Communication (Principles 17-20)
Information Quality (Principle 17): Committing to the quality, accuracy, and timeliness of information for decision-making and external disclosures, emphasizing consistent terminology and effective document retention policies.
Strategic Stakeholder Engagement (Principle 18): Identifying key internal and external stakeholders and establishing channels for information sharing, feedback, and addressing concerns. This includes shareholder engagement (e.g., through CFO, corporate secretary, IR) and board engagement with other key stakeholders (employees, regulators).
Effective Internal Communication (Principle 19): Ensuring consistent, transparent, and timely internal communication to align employees with purpose and strategy.
Transparency (Principle 20): Maintaining transparent disclosures, forming a Disclosure Committee for external reporting oversight, and safeguarding material non-public information. Entities increasingly face pressure to take public policy stances, which the board oversees.
6.5. Resilience (Principles 21-24)
Risk and Opportunity Management (Principle 21): Executive management establishes a risk management approach aligned with the entity’s strategic plan and risk appetite. The CGF references the Three Lines Model (First Line: risk and control ownership; Second Line: risk oversight; Third Line: IA providing objective assurance).
Risk Culture and Monitoring (Principle 22): Promoting a risk-aware culture and establishing monitoring processes to identify and assess risks.
Internal Control (Principle 23): Board oversight of internal control development and performance, with executive management designing and monitoring a recognized system (e.g., COSO’s Internal Control Integrated Framework). IA plays a vital role in providing assurance and insights, including assessing corporate governance effectiveness.
Monitoring Governance Effectiveness (Principle 24): Routinely monitoring governance effectiveness, evaluating internal and external changes, and refining processes for continuous improvement and long-term value creation.
What do we think?
The COSO CGF is a principles-based, integrated and comprehensive framework developed to guide entities in the rapidly evolving corporate governance environment, aligning with COSO's existing frameworks. Its core objective is to drive long-term value creation by enhancing agility, clarifying roles, and extending accountability beyond the boardroom.
It offers a strategic advantage, fostering transparency, strengthening reputation, attracting investors, and enabling proactive risk management in a complex, multi-stakeholder environment. It provides a common language and structure, beneficial for various stakeholders including boards, management, and shareholders.
The CGF is not a rigid set of rules, nor is it intended to be a new set of regulatory standards or a one-size-fits-all approach. It also does not address every highly specialized governance topic and requires entities to consult legal advisors for specific compliance however it is a worthwhile contribution towards enhancing corporate governance practices in Corporate America and beyond.
However, in the presence of existing COSO guidance covering a majority of the topics in CGF, it is important to emphasize that this framework does not necessarily replace but rather supplements these and provides a completeness sense check over an entity's corporate governance environment.