Corporate governance

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.

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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

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

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Rubber stamp

Good old boys or country club

Paper board

Trophy board

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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

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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

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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.

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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.

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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.

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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.

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Its members composition

And independence of the board

Committees

External help

Government intervention

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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

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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

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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

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Balance of representation

Balance of talents/abilities

Balance of power

Balance of attitudes

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According to composition◦ Unitary or two tiered

Tenure of the members◦ Common tenured & staggered

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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

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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

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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)

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Boards should meet in every quarter

The meetings should be properly communicated and recorded

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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….

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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

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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.

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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.

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Formalization of meetings’ conduct – avoid unwritten practices.

Formal induction of new directors Post-facto approvals should be discouraged. Proper use of board committees.

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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.

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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.

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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.

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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.

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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

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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

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