Insight into Corporate Governance
The term Corporate Governance refers to the relationship between three groups
- 1. the shareholder
- 2. board of Directors of the corporate
- 3. the management of the corporate.
The corporation is governed by the board of directors overseeing management of the company with the concurrence of its shareholders.
The investor/ Shareholder participates and provides initial capital for the company and assess the progress at annual general meetings without taking responsibility for the operation, but has the right to elect the directors proposed by the management to represent them. Management takes part in the operation of the company without being personally responsible for providing the funds for the company. Thus the board of directors have to ensure that the management runs the company efficiently.
Introduction
Corporate Directors are today faced with great pressures from Regulators, Shareholders and proxy advising firms, greater disclosures requirements, increased Board diversity, transparency, enhance Corporate Governance and ensure safety from cyberattacks. Effectiveness of the Board arises on how effective the Directors and utilization of their time meaningfully. Lot of time could be effectively used of board members by sending early board discussion documents through the use of Board Portal software which enables on-line engagement of directors while preventing cyber-attack threats. The ability of the Board to have a proper mix of directors ranging from experience and expertise from inside and outside directors of various professional disciplines, diversity goes a long way for becoming an effective Board. A proper system of succession planning such as mandatory retirement is an effective control from becoming a “phantom board”(explained below) which leave every decision activities to the CEO and Senior management or just becoming a “Rubber Stamp Board”(explained below) which merely accepts all approvals submitted by the management. Educating directors on the internal activity of the business and past trends also helps in the effectiveness of the members of the Board.
The degree of involvement with the management by the directors (not manage) also creates a viable environment. Use of Board Committees to access information and performance of the management has been the general practice.
Boards have to ensure a sound corporate governance within and at all levels of the corporate and be in breast of strategic issues that affect the company. Motivating the management to achieve the tasks required by the Investors/Shareholders being the principle responsibility of the Board of Directors.
Responsibilities of the Board of Directors
Over the past decade concerns have arisen whether the outside appointed directors possess adequate knowledge to provide guidance to the management. These concerns seem to justify considering instances of questionable accounting practices and corruptions like in cases of Enron, World.com, Tyco international Ltd. and locally in some Finance companies. In Tyco for example, the CEO treated the company as his own personal empire and handpicked top managers of his liking and personally chose the board of directors and also filtered all information going to the board. On the other hand, the Tyco’s board of directors seemed to keep the CEO happy than safe guarding the interest of the shareholders. Thus the very passivity of the Board led to the resignation of its directors in year 2003.
The general public also became aware of the apparent lack of many board of directors to take responsibility that led to push the Governments to encourage more professional boards. The responsibility of the Boards vary from country to country. In Canada, there were more federal laws governing director responsibility. Nevertheless a world-wide consensus is developing in the area of responsibilities of the board.
A universal agreed responsibilities of most directors board in interviews held with countries of France, Canada, Germany, Netherlands, Switzerland, United Kingdom and Venezuela arrived at the following 5 board of directors responsibilities-
- Setting corporate strategies, overall direction, mission or vision.
- Hiring and firing the Top management
- Controlling , monitoring top management
- Reviewing and approving the use of resources
- Caring for stockholders interest
In a legal sense, the board of directors are required to direct (not manage) the management with due care in conscientiously carrying out its responsibilities.
The degree of involvement of the board of directors may range in a continuum from phantom type to catalyst type of director board.
- Phantom boards– never bother to know anything happening in the company management
- Rubber stamp boards– permit management to make all decisions
- Minimal review – formally review only selected issues that officers bring to their attention.
- Nominal participation – involved to a limited degree of performance review and of selected key decisions or programs of management.
- Active participation – Approves, questions, and makes final decision but has an active board committees to monitor
- Catalyst – takes leading role in establishing and modifying the mission, objectives, strategy and policies and has a very active strategy committee to monitor and give direction. (Source: T. L. Wheelen and J.D Hunger- Board of directors’ continuum)
Inside & Outside Directors
Most Boards like in Government and Family-owned companies contain Inside and Outside directors. Inside directors are internal executive officers and sometimes called management directors. Outside directors or Independent Directors may be executives of other firms or retired experienced professionals and sometimes family members of Founders of the Corporate. In United States the trend is an increase in outside directors compared to inside director numbers. People favor outside Directors sometimes because they are less biased and capable of evaluating management performance effectively. Further acting selfishly to the detriment of the shareholders is avoided. The Independent Directors may also exercise their role by having Executive Sessions, which are not Board meetings but meeting of these Outside Directors chaired by the Chairman of the Board. Other the other hand, those who prefer Inside directors contend that Outside directors are less likely to have any interest due their busy schedule on their outside work.
Interlocking Directors
Further Interlocking arrangements of directors occurs within some companies who share directors( although this is prohibited in the US by the Clayton Act that substantially reduce commercial competition. For example two directors in two separate firm may serve as a director in a third company or in each other Corporates. This is also common in Government Corporations, where the treasury representatives of the Government Treasury may sit as directors in all Government owned Enterprises. Interlocking directors are a useful method of gaining internal information about the company in which they have major share holdings. Family Corporates are less likely to have interlocking directors as they do not like to dilute their corporate control.
Appointment of Directors
Traditionally in private corporates, it is the CEO who lists the names of the Directors and obtains approval of the Stockholders at an AGM or Special General Meetings. However this arrangement may lead to CEO proposing his favorites and could be dangerous, resulting in Phantom or Rubber Stamp Boards. 80% of large US Corporates now use Nominating Committees to identify potential Directors. However this practice is less common in European countries where only 60% use Nominating Committees. The term of the directors also vary from country to country. In most of the US countries only a portion of the directors stands for re-election. Arguments in favor of such practice is that it allows continuity and avoids high turnover of members and electing people unfriendly to management and resultant hostile takeover.
Organization of Boards in Corporates
75% of the publicly held Corporates of US have dual designations of Chairman and CEO, while in UK only 5% of the firms hold such posts. In Germany the Chair and the CEO’s role are separated by Law. However this duel practice has been severely criticized because of conflict of interest. Those in favor of the dual designation say that the Board can properly oversee the management. Most efficient Boards accomplish much of their work through Board committees or Oversight Committees and these Committees are granted full powers by the Board. Typical standing committees are Audit Committee, Nominating Committee, Compensation committee, etc.
Guiding Principles for Corporate Governance
The board approves corporate strategies that are intended to build sustainable long-term value; direct the chief executive officer (CEO); oversees the CEO and senior management in operating the company’s business, including approving capital for long-term growth and assessing and managing risks; and ethical conduct. Management develops and implements the corporate strategy and operates the company’s business under the Board’s Oversight Committees, with the goal of producing sustainable long-term value creation. Management, under the Oversight Finance Committees of the board produces financial statements that fairly present the company’s financial condition and results of operations and makes the timely disclosures to investors for their need to assess the financial and business soundness and risks of the company. The audit committee of the board retains and manages the relationship with the outside auditor, oversees the company’s annual financial statement, audit and internal controls over financial reporting, and also oversees the company’s risk management and compliance programs. The compensation committee of the board develops and oversees the implementation of compensation policies that fit within its philosophy, designs compensation packages for the CEO and senior management with the view to incentivize the creation of long-term value, and develops meaningful goals for performance-based compensation that support the company’s long term value creation strategy. The nominating/corporate governance committee of the board plays a leadership role in shaping the corporate governance of the company, appropriate to the company’s needs and strategy, and actively conducts succession planning for the board.
The board and management should engage on long-term issues with the shareholders and concerns that are of widespread interest to them and that affect the company’s long-term value creation. Shareholders that engage with the board and management assume some accountability for the long-term interests of the company and its shareholders as a whole. As part of this responsibility, shareholders should recognize that the board must continually weigh both short-term and long-term uses of capital when determining how to approve it in a way that is most beneficial to shareholders and to building long-term value. In making an effective board, may consider the interests of all stakeholders such as employees, customers, suppliers and the community in which the company does business, when doing so contributes in a direct and meaningful way to building long-term value creation.
An effective system of corporate governance provides the framework within which the board and management address their key responsibilities. The board also has direct responsibility for certain key matters, including the relationship with the outside auditor and executive compensation. The board’s oversight committee oversees the performance of the company’s CEO and the CEO succession planning process. The board should have meaningful input into the company’s long-term strategy from development through execution and approve the company’s strategic plans and should regularly evaluate implementation of the plans that are designed to create long-term value. The board should understand the risks inherent in the company’s strategic plans and how those risks are being managed. The board oversees the process for identifying and managing the significant risks facing the company. The board and senior management should agree on the company’s risk appetite, and the board should be comfortable that the strategic Business plans are consistent with it. On the question of integrity and clarity of the company’s financial reporting, ensure other disclosures about corporate performance. The board should be satisfied that the company’s financial statements accurately present its financial condition, results of operations and the company’s performance, convey meaningful information about past results as well as future plans, and that the company’s internal controls and procedures have been designed to detect and deter fraudulent activity. The board monitors implementation of the annual plans and assesses whether they are responsive to changing conditions. As part of its risk oversight function, the board periodically reviews management’s plans to address business resiliency, including such items as business continuity, physical security, cyber security and crisis management. The board, under the leadership of appropriate committees, oversees the company’s compliance program and remains informed about any significant compliance issues that may arise. The CEO and senior management generally take the lead in articulating a vision for the company’s future and in developing strategic plans designed to create long-term value for the company, with meaningful input from the board. Management implements the plans following board approval, regularly reviews progress against strategic plans with the board, and recommends and carries out changes to the plans as necessary. Management has to take appropriate measures in conjunction with the Board to maintain the expected return of capital to shareholders in the form of dividends and in light of changing conditions, assumptions and expectations, and keeps the board apprised of significant developments and change
Conclusion
Most companies introduce Corporate Governance mainly to ensure capital sustainability. Initially internal profits may be provided for expansion, but ultimately has to have the ability to access external capital for growth. The path for growth expansion needs to create an environment for Investor confidence. Therefore introducing Corporate Governance becomes an essential requirement for accessing new sources of finance and responding to external market pressures caused by local and global economic, political and social situations.
Balancing Shareholders issue and interests can occur due to shareholder differing interests in the Company. For e.g. shareholders representing Pension funds may requiring maximum returns on their investment, while Shareholders representing huge Industrial groups will require the Company to be price competitive. Balancing these interests pose a major challenge and it may be necessary to adopt implementing practices such as avoiding Shareholders in the same Industry as the Company. Balancing Controlling and Minority Interest concerns also pose problem. To overcome this, most companies make their securities appealing to a broader universal range of Investors.
Sustainable operational results could be achieved by attracting and retaining top level talented, committed personnel through better remuneration compensation while introducing an efficient Corporate Governance to achieve sustainability.
Having introduced a good corporate governance, the challenge still remains whether down the line any vital steps have been overlooked in the light of situational issues. Therefore, insight into the review of the Corporate Governance becomes a never-ending journey.
References- 1. Essentials of Strategic Management
By J. DAVID Hunger & Thomas L. Wheelen
2. Guidelines on Corporate Governance by Interface Diagnostics Group Inc.
3. Getting Governance Right -2017 – Hand book for today’s CEO & Board of Directors by Corporate compliance Inc.- (Publisher –Maurice Gilbert)
Mohamed Mihular Mohamed Rizley
Fellow Member of CPM Sri Lanka
Management Consultant