Never before has corporate governance received as much attention as it does now. Recent corporate scandals and questionable business ethics have forced companies and their leadership under the microscope. To deal with the problems – legislation, codes of conduct and guidelines for corporate governance practices have proliferated.
Directors are under pressure. In the early 20th century, Lord Boothby described his board meetings as resembling series of pleasant hot baths followed by food and money. The water temperature has risen lot since then!
Most of the prescriptions for improving corporate governance (including the infamous Sarbanes-Oxley Act) have focused on the structure of boards including their size, composition, independence of directors and so on. But what is the role of the board and is there relationship between board structure and corporate performance? I will consider the answers to these questions.
I will start by looking at the definition of corporate governance and what better place to look for definition than web encyclopaedia.
The definition I found is:
“Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way corporation is directed, administered or controlled.”
It includes the relationships among the many players or stakeholders involved. Of course there are numerous players and stakeholders in any business but in the context of governance there are three key ones: shareholders, management and the board of directors.
In an organisation with multiple shareholders (for example listed company) the concept of the separation of ownership and control is important in understanding how corporate governance works.
Shareholders invest but usually do not want to run or are incapable of running the company; they provide the capital and the risk appetite, but they want people with specialised knowledge to manage the business, so they appoint an agent – the board of directors – to oversee their investment on their behalf. The board is the agent for all shareholders and stakeholders.
The board of directors is the interface between the shareholders and the company and the board is ultimately accountable to the shareholders who appoint the directors. But in law the directors must act in what they consider to be the best interests of the company. This is not necessarily the same thing as acting in the best interests of shareholders. This is critical point which I find is often not that well understood and once it is understood then other aspects of corporate governance and how the board works fall into place.
So, the board oversees and directs, management manages day to day and implements, and, the board is accountable to the shareholders, management is accountable to the board.
Having set out the different roles of board and management I will briefly outline some of the fundamental functions of the board. Then I will talk about the link between board structure and corporate performance.
There are many ways to explain the functions of board and many models have been used. I have chosen to use “The Four Pillars of Effective Corporate Governance” originally formulated in the Institute’s best practice statement entitled “The Role of the Board in Adding Value”.
These pillars are:
• Determination of Purpose
• Holding to Account
• Governance Culture
• Compliance.
First, Determination of Purpose
The board must have ultimate accountability and ‘ownership’ of the company purpose and strategy.
Management will provide analysis, operational and business knowledge, research and thinking. Probably they will make recommendations to the board, but it is the board that must approve the company purpose, philosophy and strategy.
Secondly, holding to account
An effective board must ensure that it holds management to account. Few companies fail overnight. More frequently failure is the result of ongoing under-performance that accumulates over time. An example here is the recent spate of finance company collapses – you have to wonder if the boards of these companies really challenged management and understood the risks their companies were taking.
Thirdly, Governance Culture
Culture is critical in the performance of the board and the organisation as whole. Trust is important around the board table but obviously it needs to be earned. Challenge is also important. Discussion and debate need to be robust. Above all there can be no compromise on ethics and integrity. This sounds like simple aspiration, but it should be shared by both the board and management.
Boards should assess their own performance regularly and should consider issues such as the balance of skills around the table, succession planning, professional development and, crucially, whether they add value to the company. I am pleased to say that director evaluation is becoming much more commonplace and most boards undertake regular assessments. Although it may seem somewhat self-serving process, we find that self-evaluation by directors is highly effective. In reality, good boards have very low tolerance for underperformance amongst their members.
Finally, Compliance
Boards of directors need to ensure that company’s financial position is solvent and that other financial matters including audit, both internal and external are properly and effectively undertaken. As part of this process the board must also ensure that risk is managed and that formal process is put in place for assessing, managing and reporting on risk.
Directors must also be aware of other compliance issues such as regulations, delegated authorities, confidentiality, safety guidelines and many others. Some of these are common to all organisations and others will depend on the operating environment of the company.
Board Structure and Corporate Performance
I mentioned earlier that most of the prescriptions for improving corporate governance (including Sarbanes-Oxley) have focused on the structure of boards – their size, composition, independence of directors and so on, but academic research is not able to demonstrate definitive relationship between the structural characteristics of board and corporate performance.
A number of studies have attempted to define what it is that makes board successful. I read an article few months ago that said that companies that had woman on their board were more successful. As much as I might like to believe this is true I have to say that I am sceptical about such claims.
A study carried out recently by Richard Leblanc and James Gillies and published in their book Inside the Boardroom takes slightly different approach. They led research which considered how boards make decisions and determined an instinctively sensible conclusion that decision making is greatly influenced by behavioural characteristics.
The study by Leblanc and Gillies led the authors to classification of types of directors based on behaviour. They also identified that certain types were common to functional boards and others to dysfunctional boards.
The five functional or positive director behaviour types are:
• change agent
• consensus builder
• challenger
• counsellor
• conductor (for the chairman).
The five dysfunctional or negative director behavioural types are:
• controller
• conformist
• critic
• cheerleader
• caretaker (for the chairman).
Often, the dysfunctional types are mistaken for the functional. For example, the critic at the board table is well-known type, sniping at management proposals and questioning their credibility. On the other hand, director who is challenger will act to strengthen the board’s understanding through debate, then move on to decision they can support.
For boards to be functional they must show some respect to structure. For example, they need chair that facilitates debate, they
