Board of Directors and Governance MGT 427 - Corporate Governance Board of Directors and Governance Faisal AlSager Week 8

Objectives To have a detailed understanding of duties and responsibilities of directors To understand the rationale for key board committees and their functions To be able to critically assess the criteria for independence of non- executive directors

Board Duties Most jurisdictions in the US describe the directors as having two duties: Duty of Loyalty: means that directors must demonstrate unyielding and undivided loyalty to the company’s shareholders Duty of Care: means that directors must exercise due diligence in making decisions

Other Duties Other duties by the UK laws: a duty to act within powers; a duty to promote the success of the company; a duty to exercise independent judgement; a duty to exercise reasonable care, skill, and diligence; a duty to avoid conflicts of interests; a duty not to accept benefits from third parties; a duty to declare an interest on a proposed transaction or arrangement.

Board Responsibilities According to the American Law Institute, the responsibilities of the board are: Select, regularly evaluate, fix the compensation of, and, where appropriate replace the principle senior executives. Oversee the conduct of the corporation’s business to evaluate whether the business is being properly managed. Review and, where appropriate, approve the corporation financial objectives and major corporate plans. Review and, where appropriate, approve major changes in, and determinations of other major questions of choice respecting, the appropriate auditing and accounting principles and practices to be used in the preparation of the corporation’s financial statements. Perform such other functions as are prescribed by law, or assigned to the board under a standard of the corporation.

Epstein and Roy Objectives High-performance boards must achieve three core objectives: provide superior strategic guidance to ensure the company’s growth and prosperity; ensure accountability of the company to its stakeholders, including shareholders, employees, customers, suppliers, regulators, the community.. etc. ensure that highly qualified executive team is managing the company.

Committees We will discuss four committees: Audit Committee Compensation (Remuneration) Committee Nomination Committee Risk Committee

Audit Committee The most important committee Duty: acting independently from the executive, to ensure that the interests of shareholders are properly protected in relation to financial reporting and internal control Roles: oversight (system), assessment, review (scope, whistle-blowers) They should develop and appropriate monitoring system, and not monitor themselves They provide a “bridge” between internal and external auditors and the board

The Combined Code (2006) “the board should establish an audit committee of at least three, or in the case of smaller companies, two, members, who should all br independent non-executive directors. The board should satisfy itself at least one member of the audit committee has recent and relevant financial experience”

Compensation (Remuneration) Committee This is always a “hot issue” for the press It should make recommendations to the board, within agreed terms of reference, on the company’s framework of executive remuneration and its cost; It should determine on their behalf specific remuneration packages for each of the executive directors including pension rights and any compensation payments This committee prevents executives from setting their own remuneration

The Combined Code (2006) “the board should establish a remuneration committee of at least three, or in the case of smaller companies, two, members, who should all be independent non-executive directors”

Nomination Committee This committee should evaluate the existing balance of skills, knowledge, and experience on the board, and utilize this when preparing a candidate profile for new appointments The chair of the committee may be the chairman of the company or an independent non-executive director

The Combined Code (2006) According to the Combined Code (2006): Appointment of new directors should be a formal, rigorous, and transparent process, and the nomination committee should lead this process and make recommendations to the board The majority of the committee members should be independent non-executive directors

A Balanced Composition It’s important that the board has a balanced composition in terms of: executive and non-executive directors experience qualities skills

Risk Committee The misuse of risky investments led to the downfall of many companies (Lehman Brothers and Barings Bank) Thus, the risk committee should comprehend the risks involved by inter alia, using derivatives, and this would necessitate quite a high level of financial expertise and the ability to seek external professional advise where necessary

Committees and Governance Cendant Scandal Case: Audit committee met twice while compensation committee met 8 times

Non-Executive Directors Non-executive directors are a mainstay of good governance Their role has two dimensions: A control or counterweight to executive directors so that the presence of non-executive directors helps to ensure that an individual person or group cannot unduly influence the board decisions The contribution that non-executive directors can make to the overall leadership and development of the company

OECD Principles “Boards should consider assigning a sufficient number of non- executive board members capable of exercising independent judgement to tasks where there is a potential conflict of interests. Examples of such key responsibilities are financial reporting, nomination and executive and board remuneration”

Independence of NEDs In governance, independence means that there are no relationships or circumstances that might affect the director’s judgement Independence questions to ask: Was the director a former employee of the company or group within the last five years? Has the director received additional remuneration from the company? Does the director have close family ties with the company’s other directors and advisors? Has the director had a material business relationship with the company in the last three years? Has the director served the board for more than 10 years? Does the director represent a significant shareholder?

References Corporate Governance: Mallin, Tina. Oxford. Corporate Governance (4th Edition): Monks, R. and Minow, N. 2004. (Publisher: Wiley-Blackwell)