Lecture 9: Board Structure & Directors Recap Ownership structures and their impact on governance practices The prominent role of family owned firms in many countries, and the evolution of governance in family firms State ownership and the process of privatization Satyam Overview Distinction between unitary and dual boards Roles, duties, and responsibilities of board of directors in general CEO-chairman duality Executive-directors, Non-executive directors, and Independent non-executive directors Aware of the rationale for key board committees and their functions Roles of boards of directors Agency theory: the key function of the board of directors is to serve as a monitoring mechanism, to keep self-serving managers in check and result in increased value for shareholders Stakeholder theory: directors should make decisions that take account of the interests of all stakeholders in a firm (Marshall et al. 2007) School of Management 4 Roles of boards The board is responsible for determining the company's aims and the strategies, plans and policies to achieve those aims; monitoring progress in the achievement of those aims; and appointing an appropriate CEO Combined Code (2006): 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. Directors should make decisions in an objective way and in the company's best interests 5 Duties of boards To achieve these objectives, a board and its members should have: Regular meetings (4-10 per year) Appropriate reporting procedures Separated roles of CEO and Chairman A balance between inside and outside directors Access to reliable and timely information Administrative and financial support Appropriate training (e.g. SID courses) 6 Types of board structure Two types of board structure: The unitary or one-tier board (US, UK, AUS, Singapore, etc) The dual or two-tier board (Germany, the Netherlands, Denmark, Taiwan, Indonesia, and China) 7 One-tier Board Germany Two-tier Board Dutch Two-tier Board tier Board Shareholders Shareholders tier Board (Bearer Shares) tier Board Shareholders Supervisory (Outsiders & Employees) Supervisory (No Employees) Board Board Of Executives Board Of Executives Workers Council Management Management School of Management Management 8 Unitary board Unitary board: is composed of both executive (inside) and non-executive (outside) directors The main responsibilities of directors are selection of a CEO and the overseeing of that CEO and other senior managers of the corporation on a day-to-day basis Corporate governance codes usually require a strong presence of independent (outside) directors on a unitary board 9 Dual board 1. a day-to-day operation management board composed entirely of executives 2. a monitoring supervisory board composed mainly of non-executive board members Advantages of a dual board: the complete separation of the managing role and monitoring role; more clearly defined directors' responsibilities in each board; faster decisionmaking; separated roles of CEO and Chairman Disadvantages of a dual board: the upper-tier directors may lose touch with the company, while the lower-tier directors become distanced from outsiders; power imbalance between two boards (Hampel 1998) School of Management 10 Similarities between one and two tier board structures 1. Both boards will usually appoint the top managers of the company 2. Regardless of one-tier or two-tier, all board directors usually have responsibility for ensuring that financial reporting and control systems are functioning properly and for ensuring that the corporation complies with the law. 3. Both unitary board and supervisory board are usually elected by shareholders. Roles, duties, and responsibilities of board of directors Agency theory: the key function of the board of directors is to serve as a monitoring mechanism, to keep self-serving managers in check and result in increased value for shareholders Stewardship theory: managers will not engage in self-serving behaviour, but will rather act in the best interests of their shareholders. Directors' role is to empower the managers Stakeholder theory: managers should make decisions that take account of the interests of all stakeholders in a firm, because a firm's long-term value maximisation can only be realised if stakeholders' interests are met. Directors' role is to ensure that besides shareholders, other stakeholders' interests are taken into consideration for any decision making. CEO/Chairman role duality Role duality refers to those CEOs who also act concurrently as the Chairman of the Board of Directors for that company Advantages: CEO/Chairman is able to operate free from delay or restraint Disadvantages: (1) the separation of the decisionmanagement and decision-control roles disappears; (2) CEO is more powerful and the firm likely to have more serious agency problem; (3) chairman's mentoring and consulting roles are surrendered School of Management 13 CEO/Chairman role duality A separation between the CEO and Chairman has been widely recommended (Cadbury 1992; Monks and Minow 1996; Combined Code, 2006) \"The role of Chair of the board is different from that of Chief Executive Officer and it follows that one person cannot fulfil both roles without conflict. Therefore, the CEO runs the company with the Chair ensuring that the board effectively judges management's performance\" (Pension Investment Association of Canada 2001, p.3) School of Management 14 Board composition & types of directors Board composition Mix of competencies, knowledge and experience to understand and deal with the specific problems facing the company and to monitor and challenge management. (AICD 2008) Types of directors Executive directors Non-executive directors Independent non-executive directors School of Management 15 Types of Directors Director Executive Director (=Employee of the Company too) Independent Non-executive (No relationship with top mgmt or shareholder) Non-executive Director (=Non-employee) Non-independent (e.g. retired CEO, bank rep shareholder rep etc 16 Executive directors Executive director: a director who is a full-time employee of the listed company Roles and duties of executive directors: Involve in the day-to-day operation and decisionmaking process Evaluate the performance of the firm's management team and the CEO Strengths and weaknesses strong industry and business knowledge and participation in the decision-making process Lack of independence 17 Non-executive directors Non-executive director: a director who is not a fulltime employee of the company, but who maintains some form of personal or professional relationship with the firm (former executive, creditor, family connection etc) Strengths and weaknesses of non-executive directors: Control or counterweight to executive directors Contribute to the overall leadership and development of the company Not truly independent Independent non-executive directors Independence: there are no relationships or circumstances which could affect the director's judgement Independent director: plays the most important role in a board, aims to provide a means to monitor management activities, to reduce managers' opportunistic behaviour and result in a better firm financial performance But lack in-depth knowledge of company operations; may be busy with multiple directorships; may not be truly independent 19 Board composition and independence Board composition: the relative level of dependence on the CEO has implications for directors' control role (Johnson, Daily, and Ellstrand 1996) Board independence: a board in which more than half of the board members are independent directors (Byrd and Hickman 1992) Need for board independence: - A majority of independent directors (ASX, 2003; NYSE, 2003; TSE, 1994) - Half of the board members should be independent (Combined Code, 2006; Higgs 2003) - At least one-third of the board members should be independent (CSRC, 2001; CGC, 2001; SEBI, 2000) RMIT University2010 School of Management 20 Board sub-committees A board may delegate various activities to subcommittees A number of sub-committees are receiving increased attention for their role in monitoring senior management: Audit committee Remuneration committee Nomination committee Corporate Governance committee RMIT University2010 School of Management 21 Audit committee The most important sub-committee Cadbury (1992): 'A separate audit committee enables a board to delegate to a sub-committee a thorough and detailed review of audit matters, it enables the nonexecutive directors to contribute an independent judgement and play a positive role in an area for which they are particularly fitted, and it offers the auditors a direct link with the non-executive directors.' Roles of audit committee: oversight, assessment and review Independence is recommended Risk is also sometimes recommended as a particular responsibility School of the audit committee of Management 22 Remuneration committee Roles of remuneration committee: Greenbury (1995): (a) The remuneration committee is to determine the remuneration of the company's executives including the CEO, (b) to provide performance-related incentive schemes etc. and (c) to revise the remuneration package of each individual director in accordance with his/her performance Independence is recommended 23 Nomination committee Higgs (2003): The nomination committee needs to nominate and select the right candidates to fill board vacancies, as well as to evaluate an individual director's performance, to review the overall board structure and to make recommendations Ensure the balance of skills, knowledge, and experience on the board develop list of nominees for consideration of shareholders Independence is recommended 24 Corporate governance committee Less common, but gaining more importance In some companies, the governance committee is responsible for strategy: corporate vision, mission, values and relationships with stakeholders. In others the committee is more focused on legal compliance School of Management 25 Singapore Growing importance of independent directors in view of high blockholder ownership. Definition of INED (SGX Code): One who has no relationship with the company, its related companies or its officers that could interfere, or be reasonably perceived to interfere, with the exercise of the director's independent business judgment with a view to the best interests of the company. 26 Examples of Non-Independence a) a director being employed by the company or any of its related companies for the current or any of the past three financial years; b) a director who has an immediate family member who is, or has been in any of the past three financial years, employed by the company or any of its related companies as a senior executive officer whose remuneration is determined by the remuneration committee; c) a director accepting any compensation from the company or any of its related companies other than compensation for board service for the current or immediate past financial year; or d) a director being a substantial shareholder of or a partner in (with 5% or more stake), or an executive officer of, any for-profit business organization to which the company made, or from which the company received, significant payments in the current or immediate past financial year. As a guide, payments aggregated over any financial year in excess of S$200,000 should generally be deemed significant. 27 Conclusion The two types of board structure are unitary and dual boards. Please note that the advantage of one = disadvantage of the other and vice versa. CG codes have argued the need for CEO and chairman separation in view of independence. The three types of directors are executive directors, nonindependent non-executive directors and independent (nonexecutive) directors. Each has its merits and limitations. The three common board subcommittees are nomination, audit and remuneration. All advocate the need for independence. Some CG committees now starting to appear. Directors' remuneration is important to attract talents to companies. Directors' remuneration should be variable, tied28 closely to some market and accounting based outcomes. Case Study: Robert Bosch Gmbh & Singtel 1. Does the company have a unitary or dual tier board structure? 2. Describe the board composition in terms of executive, non-executive and independent non-executive directors? 3. Describe the main committees of the board, and the functions they perform? 4. Describe the composition of the various committees. Are they chaired by independent non-executive directors? 5. Are there corporate governance changes or improvements you would like to see at either company? 29 Review Questions 1. What are the main differences (strengths and weaknesses) between a unitary board system and a dual board system? 2. Which theories explain corporate governance in unitary and dual tier board systems? 3. What functions do boards perform and how do these contribute to the governance of companies? 30 Review Questions (continued) 4. What are the types of directors and what advantages and disadvantages are associated with each of these types of directors? 5. What are the main sub-committees of a unitary board and what role does each of these subcommittees play in the governance of a company? 31 References Byrd, J and Hickman, K 1992, 'Do outside directors monitor managers?', Journal of Financial Economics, v. 32, n. 2, pp. 195-221. Cadbury, A 1992, Report of the Committee on the Financial Aspects of Corporate Governance, Gee, London. http://www.ecgi.org/codes/documents/cadbury.pdf Greenbury, R 1995, Directors' Remuneration, Gee, London. http://www.ecgi.org/codes/documents/greenbury.pdf Hampel, R 1998, Committee on Corporate Governance - Final Report, Gee, London. http://www.ecgi.org/codes/documents/hampel.pdf Higgs, D 2003, Review of the Role and Effectiveness of Non-Executive Directors, Stationery Office, London. www.ecgi.org/codes/documents/higgs.pdf Hoffmann, L 1999, 'Duties of company directors', European Business Law Review, v. 10, pp. 78-84. 32 References International Corporate Governance Network 2004, Best Practices for Executive and Director Remuneration, London, ICGN. Johnson, JL, Daily, CM and Ellstrand, AE 1996, 'Research on boards of directors', Journal of Management, v. 22, pp. 409-38. Korn/Ferry 2002, 29th Annual Board of Directors Study, Korn/Ferry. www.kornferry.com.br/site/pt/pdf/mediapublications_m343.pdf KPMG 2002, Corporate Governance in Europe, London KPMG. Marshall, S et al. 2007, Company Directors' Views Regarding Stakeholders, Faculty of Law, University of Melbourne. http://cclsr.law.unimelb.edu.au/download.cfm?DownloadFile=CABCB 832-1422-207C-BA1ED9A697C1889A Monks, RAG and Minow, N 1996, Watching the Watchers: Corporate Governance in the 21st Century, Blackwell, New York, NY. 33 References OECD 2004, OECD Principles of Corporate Governance, 2nd ed., OECD, Paris. http://www.ecgi.org/codes/documents/principles_en.pdf Owen, N 2003, Report of the HIH Royal Commission, Dept of Treasury, Canberra. http://www.hihroyalcom.gov.au/finalreport/index.htm Pension Investment Association of Canada 2001, Corporate Governance Principles and Guidelines, 2nd revision, Toronto, PIAC. Sykes, R 2002, 'Overcoming poor value executive remuneration', Corporate Governance, v. 10, n. 4, pp. 256-60. 34 Week 9 Ethics & Governance: Board Structure & Directors Cases: Robert Bosh Gmbh & Singtel In groups of 3-5 research the corporate governance of both companies (board structure, directors, board composition and board committees) using internet sources such as company websites and Wikipedia. Robert Bosch Gmbh (Germany) www.bosch.com Singtel http://info.singtel.com/about-us/corporate-governance Case Questions 1. Does the company have a unitary or dual tier board structure? 2. Describe the board composition in terms of executive, non-executive and independent non-executive directors? 3. Describe the main committees of the board, and the functions they perform? 4. Describe the composition of the various committees. Are they chaired by independent non-executive directors? 5. Are there corporate governance changes or improvements you would like to see at either company? Review Questions 1. What are the main differences (strengths and weaknesses) between a unitary board system and a dual board system? 2. Which theories explain corporate governance in unitary and dual tier board systems? 3. What functions do boards perform and how do these contribute to the governance of companies? 4. What are the types of directors and what advantages and disadvantages are associated with each of these types of directors? 5. What are the main sub-committees of a unitary board and what role does each of these subcommittees play in the governance of a company