Last Updated 17 Jun 2020

Corporate Governance – Role of Board of Directors

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CORPORATE GOVERNANCE - ROLE OF BOARD OF DIRECTORS People often question whether corporate boards matter because their day-today impact is difficult to observe. But, when things go wrong, they can become the center of attention. Certainly this was true of the Enron, Worldcom, and Parmalat scandals. The directors of Enron and Worldcom, in particular, were held liable for the fraud that occurred: Enron directors had to pay $168 million to investor plaintiffs, of which $13 million was out of pocket (not covered by insurance); and Worldcom directors had to pay $36 million, of which $18 million was out of pocket.

As a consequence of these scandals and ongoing concerns about corporate governance, boards have been at the center of the policy debate concerning governance reform and the focus of considerable academic research. Because of this renewed interest in boardsmuch of the research on boards ultimately touches on the question “what is the role of the board? ” Possible answers range from boards’ being simply legal necessities, something akin to the wearing of wigs in English courts, to their playing an active part in the overall management and control of the corporation.

No doubt the truth lies somewhere between these extremes; indeed, there are probably multiple truths when this question is asked of different firms, in different countries, or in different periods. So what is a Board of Director (BoD) and what do Directors actually do? “A Board of Directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors.

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It is often simply referred to as ‘the board’ ”. A board's activities are determined by the powers, duties, and responsibilities delegated to it or conferred on it by an authority outside itself. These matters are typically detailed in the country’s company law, organization's bylaws and/or the Article of Association (AoA). The bylaws commonly also specify the number of members of the board, how they are to be chosen, and when they are to meet. To better understand corporate boards, one should begin with the question of what do directors do’? Over the years there has been several indepth studies conducted and research literature published by some of the most brilliant academics only to answer this very question e. g. Mace, 1971, Whisler, 1984, Lorsch and MacIver, 1989, Demb and Neubauer, 1992, and Bowen, 1994 and their conclusions are presented breifly: The principal conclusions of Mace were that “directors serve as a source of advice and counsel, serve as some sort of discipline, and act in crisis situations”.

The nature of their “advice and counsel” is unclear but Mace suggests that a board serves largely as a sounding board for the CEO and top management, occasionally providing expertise when a firm faces an issue about which one or more board members are expert. Yet Demb and Neubauer’s survey results find that approximately two-thirds of directors agreed that “setting the strategic direction of the company” was one of the jobs they did. 80% of the directors also agreed that they were “involved in setting strategy for the company”. 5% of respondents to another of Demb and Neubauer’s questionnaires report that they “set strategy, corporate policies, overall direction, mission, vision”. Indeed far more respondents agreed with that description of their job than agreed with the statements that their job entailed “oversee[ing], monitor[ing] top management, CEO” (45%); “succession, hiring/firing CEO and top management” (26%); or serving as a “watchdog for shareholders, dividends” (23%). According to Epstein and Roy (2006), a high performance board must achieve three core objectives; in other words Epstein and Roy nail the core responsibilities of the board: . Provide superior strategic guidance to ensure the company's growth and prosperity by Setting of Strategy: 2. Ensure accountability of the company to its stakeholders, including shareholders, employees, customers, suppliers, regulators and community; 3. Ensure that a highly qualified executive team is managing the company by The Hiring, Firing and Assessment of Management. Apart from what has been stated above one very significant and active role played by the board is in terms of "the hiring, firing, and assessment of management".

This is one role that is typically ascribed to directors is control of the process by which top executives are hired, promoted, assessed, and, if necessary, dismissed. Assessment can be seen as having two components, one is monitoring of what top management does and the other is determining the intrinsic ability of top management. The monitoring of managerial actions can, in part, be seen as part of a board’s obligation to be vigilant against managerial malfeasance. It is essential that the role, duties and responsibilities of directors are clearly defined.

The Combined Code (2006) states that “the board’s role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls which enables risk to be assessed and managed”. According to UK Law, the directors should act in good faith in the interest of the company, and exercise care and skill in carrying out their duties. The Company Law Reform Bill (2005) defines, in section 154-161, the directors’ duties as follows: • a duty to act within powers, that is, to act in accordance with the company’s constitution and only exercise powers for the purpose for which they are conferred; a duty to promote the success of the company, so a director must act in the way he considers, in good faith, would be most likely to promote success of the company for the benefit of its members as a whole; • a duty to exercise independent judgment; • a duty to exercise reasonable care, skill and diligence; • a duty to avoid conflicts of interest; • a duty not to accept benefits from third party • a duty to declare an interest on proposed transactions or arrangements. But that does not quite answer our cardinal question as to ‘how the role the board plays is related to the overall corporate governance of the organization’.

Nevertheless one thing is certain thus far is that the BoD lead and control a company and hence an effective board is fundamental to the success of the company. The board is the link between managers and the investors, and is essential to good corporate governance and investor relations. Since corporate governance represents the value framework, the ethical framework and the moral framework under which business decisions are taken; it therefore calls for three factors: 1. Transparency in decision-making; 2. Accountability which follows from transparency because responsibilities could be fixed easily for actions taken or not taken, and; . The accountability is for the safeguarding the interests of the stakeholders and the investors in the organization. Decisions relating to board composition and structure will be of fundamental importance in determining whether, and to what extent, the board is effective and successful in achieving these objectives. A board will typically be composed of a Chairman, Chief Executive Officer, Executive Directors, Non- Executive Director, Independent Director, Company Secretary and then there are committees made from among the board for specific purposes with a view to increased corporate governance and hence accountability.

It is important that the board has a balanced composition both in terms of executive and non executive directors and also in terms of experience, qualities and skills that individuals bring to the table. The Institute of Directors (IoD) has published some useful guidance in this area in 2006 which is shared below: • Consider the ratio and number of executive and non executive directors. • Consider the energy, experience, knowledge, skill and personal attributes of current and prospective directors in relation to the future needs of the board as a whole, and develop specifications and processes for new appointments, as necessary. Consider the cohesion, dynamic tension and diversity of the board and its leadership by the chairman. • Make and review succession plans for directors and the company secretary. • Where necessary, remove incompetent or unsuitable directors of the company secretary, taking relevant legal, contractual, ethical and commercial matter into account. • Agree proper procedures for electing a chairman and appointing the managing director and other directors. • Identify potential candidates of the board, make selection and agree terms of appointment and remuneration.

New appointments should be agreed by every board member. • Provide new board members with a comprehensive induction to board process, and policies, inclusion to the company and to their new role. • Monitor and appraise each individual’s performance, behavior, knowledge, effectiveness and values rigorously and regularly. • Identify development needs and training opportunities for existing and potential directors and the company secretary. Roles of the board members 1. Chief Executive Officer and Chairman

The CEO has the executive responsibility for running of the company’s business; on the other hand, the Chairman has responsibility for the running of the board. The two roles should not therefore be combined and carried out by one person Conclusions Corporate governance, and in particular the role of boards of directors, has been the topic of much attention lately. Although this attention is particularly topical due to well-publicized governance failures and subsequent regulatory changes, corporate governance is an area of longstanding interest in economics (dating back to at least Adam Smith, 1776).

Because of corporations’ enormous share of economic activity in modern economies, the extent to which corporations deviate from value-maximization is extremely important. Consequently, corporate governance and the role of boards of directors is an issue of fundamental importance in economics. Understanding the role of boards is vital both for our understanding of corporate behavior and with respect to setting policy to regulate corporate activities.

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