Board of Directors: Corporate governance

Learning Objectives Examine the duties and liabilities that come with directorship. Overview of the role of the board and the requirement for independence. Review the basic operations of the board. Examine the legal responsibilities that come with directorship and consider the potential liability directors face when they fail to uphold their duties.

Board as the principle instrument of governance Shareholders own the company but do not run it Managers run the company but do not own it The bridge – Board Good board = better governance & vice versa

Entrepreneurial Leadership Profit, but: Regard to social responsibility Prudence Risk management Strategic

Types of ineffective boards Rubber stamp Good old boys or country club Paper board Trophy board

Powers of a board Absolute or maximum powers Whatever the company is authorized to do through its MoA (Memorandum of Association), the board can do it on behalf of the company In Pk (Pakistan), the board draws powers from: The company’s constitution The law – Companies Act Resolutions passed by shareholders Prevailing industry practices

Delegations of powers by the board Possible… E.g., signing of loan documents by CEO or CFO But should come with establishment of the system to keep the things in the right way

Board Responsibilities A document titled “Principles of Corporate Governance”, the Organization for Economic Cooperation and Development (OECD) lays out a vision of the responsibilities of the board: The 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.

Board Responsibilities (Con’t) From this we can conclude that the board is suppose to perform two functions: Advisory Oversight In an advisory capacity: The board consults with management regarding the strategic and operational direction of the company. Attention is paid to decisions that balance risk and reward. Board members are (should be) selected based on the skill and expertise they offer for this purpose, including previous experience in a relevant industry or function.

Board Responsibilities (Con’t) In an oversight capacity: The board is expected to monitor management and ensure that it is acting diligently in the interests of shareholders. The board hires and fires the chief executive officer, measures corporate performance, evaluates management contribution to performance, and awards compensation. It also oversees legal and regulatory compliance, including the audit process, reporting requirements for publicly traded companies, and industry-specific regulations. In fulfilling these responsibilities, the board often relies on the advice of legal counsel and other paid professionals, such as external auditors, executive recruiters, compensation consultants, investment bankers, and tax advisors. Effective board members are individuals that can capably complete both advisory and oversight responsibilities.

Board Responsibilities (Con’t) The responsibilities of directors are separate and distinct from those of management. Directors are expected to advise on corporate strategy but do not develop the strategy. They are expected to ensure the integrity of the financial statements but do not prepare the statements themselves. The board is not an extension of management. It is a governing body elected to represent the interests of shareholders.

Tools available to a board Its members composition And independence of the board Committees External help Government intervention

Responsibilities of a Board Acting in the best interest of the company Accountability to the owners (formally and informally) Statutory duties Keeping records Reporting to SECP Stock exchange reports

Responsibilities of a Board (cont’d) Fiduciary or trusteeship duties Board is the trustee Good faith Avoid conflict of interest Borrowing powers of the board Board has the unlimited powers to borrow for their companies Problem for the investors and CG proponents SBP – all directors must extend personal guarantees for the loans

Board Independence In order to carry out the two functions discussed earlier – independence of the board members has been suggested. Regulatory requirement also suggests that the director is free from conflict of interest, that might compromise his efforts For example; NYSE requires that listed companies have a majority of independent directors Similarly the audit, compensation and monitoring and governance committees should be wholly independent Pk… (ref to CG Code 2012) However, independence can be affected by several factors An informal study by Harvard’s professors suggest that relevant experience is more important than independence

Balance on the board Balance of representation Balance of talents/abilities Balance of power Balance of attitudes

Board structures According to composition Tenure of the members Unitary or two tiered Tenure of the members Common tenured & staggered

Causes of absence of balance in a board Unbalanced boards Majority of boards are based on family/friends Independent directors are not independent No talent in the boards Not efforts to extend boards influence

Operations of the Board Chairman’s role Presiding officer Sets the agenda, schedule meeting, coordinating of the committees (Coms:) Very important role Traditionally CEO used to hold chairmanship The dual role – its problems Nowadays, Non-Executive Directors assume this responsibility Sarbanes Oxley Act (SOX 2002) view Rejected the idea of independent directors chairman Concept of lead director

Operations of the Board Board’s actions take place by either arranging meetings or written consents but in any case they are done through voting. Independent directors are also suppose to meet at least once a year to discuss the different issues pertaining to the affairs of the company though no actions take place (this is requirement under S-OX 2002)

Operations of the Board Boards should meet in every quarter The meetings should be properly communicated and recorded

Operations of the Board Issues at the boards to be discussed Annual plans, cash flows, strategic plans Periodic reports Internal audit reports, joint ventures, agreements etc And many others as given on pp83 and refer to the CG 2012….

Operations of the Board Directors spend around 20 Hrs/Month on board matters Typical meeting of the directors range from 2-6 Hr and more Board and its committees Full board Standing or ad hoc committees Assigned directors on qualifications and experience Audit, compensation, governance, nominating committees Essentially composed of independent directors under SOX 2002

Cadbury Code Regular and frequent meetings Effective control over the company Important decisions should not be taken by executives, but referred to Board. Definition of which decisions should be referred to Board. Good board room practices.

Good Boardroom Practice Background information must be provided to the directors. All directors must get the same information and same time to study it. Directors should be able to participate. Certain matters, even if delegate-able should not be delegated to the executive.

Good Boardroom Practice Formalization of meetings’ conduct – avoid unwritten practices. Formal induction of new directors Post-facto approvals should be discouraged. Proper use of board committees.

Directors Duration Traditionally, directors are elected annually to one year terms. In some companies, directors are elected to two- or three-year terms, with a subset of directors standing for reelection each year. Companies that follow this protocol are referred to as having staggered (or classified) boards. Under a typical staggered board, directors are elected to three- year terms, with one-third of the board standing for reelection every three years. As a result, it is not possible for the board to be ousted in a single year; two election cycles are needed for a majority of the board to turn over.

Directors Duration (Cont’d) In recent years, however, the trend has reversed. Companies have come under fire from shareholder activists and proxy advisory firms who believe that staggered board elections insulate directors from shareholder influence. Institutional investors, particularly public pension plans, often have policies of opposing staggered boards. Some public companies have responded to shareholder pressure by de-staggering their boards. In 2009, about 50 percent of publicly traded companies had staggered boards, down from 63 percent in 2002.

Directors Elections In most companies, the board of directors is elected by shareholders on a one-share, one-vote basis. For example, if there are nine seats on a board, a shareholder with 100 shares can cast 100 votes for each of the nine people nominated. Shareholders who do not want to vote for one or all of the nominees can withhold votes for selected individuals. Directors win an election by obtaining a plurality of votes, meaning that the directors who receive the most votes win, regardless of whether they receive a majority of votes. Alternative options are: dual class voting; majority voting & cumulative voting In an uncontested election, a director is elected as long as he or she receives at least one vote.

Removal of Directors Once elected, directors generally serve their full term—one year for annually elected boards and three years for staggered boards. Shareholders may be able to prevent directors from being re- elected at the next election by withholding votes. Their ability to do so, however, depends on the voting procedures in place. They can also replace directors at the next election if a competing slate of nominees is put up for election. Finally, unless a company’s certificate of incorporation provides otherwise, shareholders may vote to “remove” a director between meetings. That said, shareholder power to remove a director is generally limited.

Legal Obligations of Directors Fiduciary responsibilities to act in the interest of the company Means that director is expected to act in the interest of shareholders A duty of care A duty of loyalty A duty of candor Legal responsibilities as defined by the regulators/government

Legal Obligations of Directors (Cont’d)

Results of a survey Issues discussed by the directors include: Profitability and shareholders value Future growth Risk management Development of human capital Cultural development Executive compensation Regulatory compliance Strategic planning Competition Succession planning