Corporate Governance- Directors’ Role

The corporate governance policy of a company should be specific and developed by each company clarifying the responsibilities of the board, role of its independent directors and set out the ethical standards for the company. Such a corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders.

Before setting out the directors’ role in governance it is useful to understand the definition as noted by Sir Adrian Cadbury, UK, Commission Report: Corporate Governance in 1992. “Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations and society.” In order to achieve an alignment of varying interests, it is important that the board sets in motion a values based system, involve in strategic direction and focus on the longer term interest of the company. Among the many aspects of a director’s role in governance some of the key aspects are highlighted below:

Strategic oversight:
The board should be involved in the development of the strategy and risk oversight. However, in some local companies, the board’s role in practice has been minimal and reactive – instead, majority shareholders consult with executives to set the strategic direction of the company and manage risk. This not a satisfactory method. The strategy should be regarded as a fundamental board issue. The whole board should be involved in strategic development – the executive directors should have in-depth knowledge about the company’s competitive position, while non-executive directors should provide an outside perspective.

The board should also put in place a mechanism to determine whether management is effectively executing the strategy. The board should discuss with management the types of reports management will submit to the board, and become involved in monitoring plans and targets.

At the KPMG’s 9th Annual Audit Committee Issues Conference one of the challenges noted relates to the board’s agenda on strategy as follows; “Economic and political uncertainty, the impact of government regulation and public policy initiatives, and ensuring that the company’s strategy keeps pace with a fast-changing business and risk environment are among the challenges facing companies and board agendas in 2013”

Risk management:
In addition to the board’s direction in strategy and selection of a CEO, the next key responsibility may be managing risk. The board needs to truly understand where the company’s risks lie in all areas, which may include all types of financial risks, market risk, investor risk, operational and reputational risk. The board has to ensure that mitigation of the key risks identified is part of the board agenda. Because, as noted by the billionaire investor Warren Buffett – “Risk comes from not knowing what you’re doing.”

Managing risks is all about measuring and prioritizing risks so that risks are managed within defined tolerance thresholds without being over controlled or foregoing desirable opportunities. This requires the board to build a risk assessment process that is suitable for the entity.

The board should have assertive individuals to ensure that it is not blindsided by success. When a company is successful directors should not be shy to ask questions and discuss how they’re successful. When a company is successful and the CEO is successful, the board and management often have stars in their eyes and tend to look the other way. This type of culture has led to many large corporate frauds like the Barings Bank, Societe Generale, UBS,etc.

The story of Kweku Adoboli, the rogue trader, who brought the Swiss banking giant UBS to its knees with losses of £7.5bn supports the above argument. Adoboli told his trial “We were told to push the boundaries, so we pushed the boundaries. We were told you wouldn’t know where the limit of the boundary was until you got a slap on the back of the wrist. We found that boundary, we found the edge, we fell off and got arrested”. The prosecuting lawyer summed it well, “you played God in that bank, tearing up the rules and doing whatever you wanted. Rules were for other people: that was your attitude.”

Setting the right Tone at the Top:
Some may say that Adoboli’s behaviour was encouraged by the culture and tone of the ethical standards set by the board. To make the objectives of the board clear and operational, many companies have found it useful to develop company codes of conduct. Establishing a common operating philosophy of ethics and values in business is one of the toughest challenges for the board and top management.

The board has a key role in setting the ethical tone of a company, not only by its own actions, but also in appointing and overseeing key executives and consequently the management in general. High ethical standards are in the long term interests of the company as a means to make it credible and trustworthy, not only in day-to-day operations but also with respect to longer term commitments. Any such standard should be communicated to all levels within the company to ensure that decisions should be made in accordance with the values framework and that breaches will be penalised appropriately. The board should also focus on ensuring that employees recruited embody the values of the company.

In business ethics, there are ‘no lone gunmen’ – the theory that integrity failures are caused by just one person behaving badly is not tenable. UBS was fined £29.7mn by the FSA for failures in its systems and controls that resulted in Britain’s biggest bank fraud, HSBC was fined £1.9bn for not preventing money laundering, LIBOR fixing fines, etc, are all ethical crises. Integrity crises are usually the result of gradual erosion in behaviour over time, which develop into an unethical culture, rather than one person acting on his own.

Diversity and nomination committees:
Most boards reflect the majority shareholder interest rather than the broader stakeholder interests in how and who they recruit into their ranks. Boards should establish a proper nomination committee to encourage a diversity discussion in appointing the right people to its board. Such discussions should focus on the composition of women, professions, age of new directors, etc. An ideal board composition strategy should take into account the most appropriate skills and competencies, experience, organisational ‘fit’ and the market profile of the business.

When the board composition is not balanced and is made up of yes men who support the major shareholder or the CEO, the company cannot be expected to be transparent and well governed. This runs the risk of boards perpetuating themselves in terms of a similar demographic background and people they know.

Remuneration policy:
It is common knowledge that remuneration and incentive schemes can promote fraud and misreporting if not designed and controlled well. In an increasing number of countries it is regarded as good practice for boards to develop and disclose a remuneration policy statement covering board members and key executives. Further, it is considered a good practice to establish a remuneration committee with independent directors to manage the policy and employment contracts for board members and key executives.

Such policy statements specify the relationship between remuneration and performance, and include measurable standards that emphasise the longer run interests of the company over short term considerations. Policy statements generally tend to set conditions for payments to board members for extra-board activities, such as consulting. They also often specify terms to be observed by board members and key executives about holding and trading the stock of the company, procedures to be followed in granting of options and payments to be made when terminating the contract of key executives.

Oversee disclosure and communications:
Directors are responsible for ensuring the integrity of the company’s accounting and financial reporting systems, including the independent audit, and that appropriate systems of control are in place for compliance with laws and relevant standards. Timely communication of results and avoiding insider dealing opportunities is also a good governance practice. This would include monitoring and managing potential conflicts of interest of board members and shareholders, including misuse of corporate assets and abuse in related party transactions.

This write up may not be complete without looking at the ethos that makes great boards what they are. Extracts of some findings by Jeffrey A. Sonnenfeld, Senior Associate Dean for Executive Programs and Lester Crown Professor in the Practice of Management at Yale School of Management, is included below to highlight many other aspects that the directors should focus to complete their role towards achieving good corporate governance.

What Makes Great Boards Great
It’s not rules and regulations. It’s the way people work together.
by Jeffrey A. Sonnenfeld.

Building an Effective Board
Good board governance can’t be legislated, but it can be built over time. Your best bets for success:

Create a climate of trust and candor
Share important information with directors in time for them to read and digest it. Rotate board members through small groups and committees so they spend time together meeting key company personnel and inspecting company sites. Work to eliminate polarizing factions.

Foster a culture of open dissent
If you’re the CEO, don’t punish mavericks or dissenters, even if they’re sometime pains in the neck. Dissent is not the same thing as disloyalty. Use your own resistance as an opportunity to learn. Probe silent board members for their opinions, and ask them to justify their positions. If you’re asked to join a board, say no if you detect pressure to conform to the majority. Leave a board if the CEO expects obedience. Otherwise, you put your wealth and reputation – as well as the assets and reputation of the company – at risk.

Utilize a fluid portfolio of roles
Don’t allow directors to get trapped in rigid, typecast positions. Ask them to develop alternative scenarios to evaluate strategic decisions, and push them to challenge their own roles and assumptions. Do the same thing yourself.

Ensure individual accountability
Give directors tasks that require them to inform the rest of the board about strategic and operational issues the company faces. This may involve collecting external data, meeting with customers, anonymously visiting plants and stores in the field, and cultivating links to outside parties critical to the company.

Evaluate the board’s performance
Examine directors’ confidence in the integrity of the enterprise, the quality of the discussions at the board meetings, the credibility of reports, the use of constructive professional conflict, the level of interpersonal cohesion, and the degree of knowledge. In evaluating individuals, go beyond reputations, résumés, and skills to look at initiative, roles and participation in discussions, and energy levels.

About surenraj

“Views expressed are my own”
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