Building a Foundation of Excellence in ESOP Governance
As of 2024, an estimated 6,300 companies operate with an ESOP, and that number only grows with each passing year.
Those who have the privilege of being an ESOP board member are likely familiar with the complex nature of running these types of companies.
Governance of such a unique arrangement can undoubtedly be challenging, but it’s vital to maximize the value of an ESOP plan for the employees who invest in and rely on it.
For those looking to enhance the effectiveness of their ESOP board, discover what you need to know about the principles of a properly functioning board and get four tips to help your colleagues begin moving toward the goal of better governance.
What Are the Responsibilities of a Properly Functioning ESOP Board?
All boards of directors have a fiduciary duty to act in the best interests of the company. To do that, boards often take on three key responsibilities.
First, boards are responsible for the duty of care. Members promise to display competence and exercise sound business judgment. They must prepare for and participate in meetings, make informed decisions, and see and investigate potential issues.
Additionally, board members have a duty of loyalty to the organization. They vow to disclose any conflicts of interest and recuse themselves from decisions and discussions that involve those conflicts. Finally, properly functioning boards have a duty of obedience — to the law, to the mission of the company, and to the limits and boundaries placed on the board’s power.
In light of these duties and responsibilities, it’s important to note that ESOP boards often play a more active role in the company than the boards of other types of companies. As such, it’s important that they remain focused on growing shareholder value. Doing so upholds their duties of care, loyalty, and obedience and ensures that plan participants get the maximum return possible.
Additionally, the board needs to oversee the succession planning process and provide sound advice to the company CEO in terms of strategic decisions, development and oversight of the company mission, reviewing financial activity, and ensuring ethical behavior.
How Boards Can Ensure the Best Possible Governance
Good corporate governance doesn’t just include legal compliance. It’s also a fulfillment of the duty that board members have to be loyal to the organization and act in its best interests. However, here are a few specific ways that board members can ensure that they fulfill their roles and work toward success.
Focus on Strategy — Not Management
The ESOP board of directors doesn’t generally run the company. The management team usually takes care of that.
Instead, the board should shift its focus to more strategic matters. This includes:
- Setting the company’s strategic direction
- Reviewing significant transactions
- Building an environment of ethics and compliance
- Setting the corporate philosophy and mission that drives everyday activity
Operating like this ensures a clear delineation of roles between the board and company management, which ultimately keeps both teams functioning effectively.
Additionally, it ensures that the board of directors always remains ten steps ahead of the management team and isn’t forsaking its responsibility to provide direction for the future instead of getting bogged down in present matters.
Reconsider the Authority of the Chairman
Although many companies give chairmen a position of authority over and above that of other members in order to streamline operations and establish a clear go-to authority in case of conflict, it isn’t always the best way forward for ESOPs.
A better alternative involves allowing the chairman to carry out organizational duties while affording them the same treatment as other board members. In this arrangement, a chairman cannot override group decisions in meetings.
ESOPs allow everyone to feel that their voices matter. It also ensures that everyone can contribute their ideas and expertise to the company’s success. Keeping the chairman’s role in line with that of other group members helps uphold the principles ESOPs follow.
Have Outside Perspectives on the Board
A growing number of experts believe that ESOP boards need outside directors and influences. Many of them are populated by internal employees and led by the CEO, who also acts as the chairman of the board. In fact, statistics show that this represents the truth for the majority of cases; 51% of ESOP companies operate this way.
Unfortunately, this type of board structure compromises the board’s ability to maintain a strategic focus and can silence the other board members in favor of the CEO’s agenda. Including outside directors helps boards avoid negative scenarios, keep conflicts of interest at bay, build trust with each other, and maintain credibility with all stakeholders.
Understand the Law Fully to Fulfill Fiduciary Duty
Running an ESOP company requires different insight than operating a traditional corporation.
These plans are governed by the Employee Retirement Income Security Act (ERISA), the same law that governs other familiar retirement plans, such as 401(k) and pension plans. Consequently, boards must follow a plethora of rules and regulations to stay in compliance.
Good governance means that all board members need to work toward understanding the ins and outs of these regulations and how they affect board decisions.
This not only keeps the board and the company out of trouble, but it also helps to maximize returns for shareholders.
A Well-Functioning Board Leads to Governance Success
Running an ESOP company can be rewarding for everyone involved, but only when it’s governed well. Board members need to adhere to their duties of care, loyalty, and obedience.
However, it also means not forsaking critical principles that allow the board to run smoothly. Boards should continue to focus on strategy, avoid treating the chairman as an authority, and ensure the presence of independent perspectives are valued.
Additionally, all members of the board should work toward a full understanding of the laws that govern their company. Not only do these actions and attitudes ensure the company’s ability to comply with the law, but they also build the right foundation for long-term business success.
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