MOS 4422: Corporate GovernanceThe Role of the Board of Directors

Trevor HunterKing’s University College

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Guiding Principles2

What we need to remember when we think about corporate governance:

1.Shareholders, not stakeholders own the company•The source of ownership authority, therefore the group to whom the Board is directly accountable and with whom the principal-agent relationship exists

• In this climate of “occupy” and corporate social responsibility there is a trend to forget this important fact and duty2The following are adapted from: Carver, J. What continues to be wrong with corporate governance . . .and how to fix it.

Ivey Business Journal, September/October 2003.

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Guiding Principles

2. The Board is the only shareholder representative and is only accountable to them:

•The Board’s primary obligation is to the shareholders, not the management or the organization itself. In fact, the Board has no obligation to itself either.

•The Board must always do what is in the best interest of the shareholders even if that hurts other stakeholders because the Board exists because of and for the shareholders

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Guiding Principles

3. The authority of the Board is group authority, not delegated or fragmented to individuals or committees:•The work of the Board may be done in committees, and it may be represented by an individual, but all decisions are made by the Board as a whole and it is that group that is responsible and accountable

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Guiding Principles

4. The Board is a permanent, active part of the organization that exists to command, not advise:•The Board is not on standby, it is always actively engaged.

•The board may provide advice to the CEO but that is only a secondary function. Its first job is to “empower and evaluate management”.

•The Board must be engaged or else it is useless

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Guiding Principles

5. The CEO works for the Board:•The CEO does not “manage” the Board.

•The Board sets the agenda, determines CEO performance goals, sets CEO compensation and receives reports from the CEO as determined by the Board.

•Only the Board as a whole tells the CEO what to do – ensures group accountability and reduces risk of malfeasance

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Guiding Principles

6. The Chair works for the Board:•The Chair is accountable to the Board.

•Commonly, the Chair is considered to be the “boss” of the Board and therefore the “boss” of the organization – this misinterprets the role of the Chair and gives them special status that effectively and wrongly diminishes the role of the Board.

•Chair aids in smooth operations of the Board but is not “the boss” but has no more importance than any other director

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Guiding Principles

7. The Chair and CEO are separate roles:•These are two different jobs and require different skills.

•Two different jobs that require two different people – one person cannot fill two different and sometimes conflicting requirements

•Absolutely essential to ensure Board independence and focus on shareholders

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Guiding Principles

8. The Board’s authority derives from shareholders, not from management:•Governance authority derives from ownership, not from management. Management authority is derived from governance.

•The Board’s authority comes from the owners, not the management – that is the primary relationship.

•Must remember that the Board’s ability to govern comes from a legal status as the owners’ representative not because management allows it.

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Guiding Principles

9. The Board must add value to ownership not

management:•The Board must make the owners’ property better, not make the managers’ jobs easier.

•Often directors are added based on their ability to help the management or organization when in fact they should be there to help the Board help the owners.

• If management needs help they can ask the Board but this must not compromise the directors’ primary responsibility

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Doing Corporate Governance

Structure:•Main board often divided into various committees – dependent upon needs and type of organization

Directors:• Individuals who have related experience • Prominence • Leaders•Competency

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Doing Corporate Governance

Committees - where the real work of the BOD gets done•Audit•Governance•H/R, nominating, recruitment• Finance•Risk

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Doing Corporate Governance

Objectives:•Provide oversight of the corporation’s management to ensure and enhance shareholder wealth maximization

Principal Parties:•Shareholders, directors, and management

Other stakeholders:•Employees, the community, suppliers, creditors and customers

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Doing Corporate Governance

Limitations:•Corporate governance not an end to itself

•Good corporate governance will not guarantee good performance

•Different perspectives as to what a BOD should do, what a director should do and what governance is

•Often, people think they can be a director when really they should not be one

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Board Responsibilities

Stewardship of the corporation•Oversee the conduct of the business and supervise management, not run the business.•Ensure adherence to corporate mission – established by owners•Approve strategic plan•Communicate with shareholders

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Board Responsibilities

Specific responsibilities:•Approve strategic planning process and strategic plan

•Manage risk•Appoint, monitor and evaluate CEO•Create and foster a shareholder communication policy

•Maintain the integrity of corporate internal control (financial) and management information systems

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Board Responsibilities

•Balance the interests of the shareholders and corporation and act in accordance with what is best for shareholders.•Difficult to do sometimes. At times the two are at odds and short-term/long-term ramifications must be considered – timeframe is an important consideration• In general the shareholders and board members are far removed from each other despite the fact that the board is supposed to represent their interests

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Board Responsibilities

•Shareholder /corporation lines of communication:•Boards are responsible for ensuring that accurate and timely information regarding the operations of the corporation are communicated to shareholders

•Shareholders are becoming proactive in communicating with boards

•Institutional investors and shareholder activism raising the bar of BOD performance expectations

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Relationship between BOD and Management

Relationship of the board to management:•Board is not involved in day-to-day operations of the firm – oversight not management

•The Board •Evaluates CEO performance and sets compensation policy and levels

•Hires/fires CEO•Approves strategic plan ensuring it is aimed at fulfilling corporate mission

•Ensures all management activities focused on maximizing shareholder wealth

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Relationship between BOD and Management

Board should function independently of management:•Separate chair and CEO positions•Audit and compensation committees composed of outside directors

•Problem – The Board is dependent upon management for information

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Developments in Corporate Governance

Recognition that status quo is not appropriate - high-level reports recommended changes to Canadian Boards:

• The Dey Report (1994)• Five Years to the Dey (1999)• Saucier Report (2001)• Davis Governance Insights (2011)

• In general, the Dey report found that Canadian corporate governance was in poor shape.

•Unfortunately, years later, subsequent reports found that although there was some improvement, much more was still needed.

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Developments in Corporate Governance

Sarbanes/Oxley Act – USA (2002)2

• Intended to "deter and punish corporate and accounting fraud and corruption, ensure justice for wrongdoers, and protect the interests of workers and shareholders" (Quote: President G.W. Bush).

2Source: http://www.sarbanes-oxley-forum.com/

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Developments in Corporate Governance

Sarbanes/Oxley Act – USA (2002)2

•Signed into law on 30th July 2002, and introduced highly significant legislative changes to financial practice and corporate governance regulation. It introduced stringent new rules with the stated objective: "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws". 2Source: http://www.sarbanes-oxley-forum.com/

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Developments in Corporate Governance

Sarbanes/Oxley Act – USA (2002)•Applicable to all companies with shares traded on American stock exchanges•Includes Canadian companies due to cross-listing• Of the 100 largest firms on the TSX, 90 are cross-listed in the USA4

•Focuses mainly on financial oversight role of Board •Led to BOD becoming more compliance oriented than strategy oriented• Not producing better governance

4 http://www.tfmsl.ca/docs/V4(3A)%20Nicholls.pdf

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Developments in Corporate Governance

Typical cost of Sarbanes/Oxley compliance in US firms (by revenue), 20103

3http://www.protiviti.com/en-US/Insights/Browse-by-Content/Surveys/Documents/2011-SOX-Compliance-Survey-

Protiviti.pdf

$100 million - $499.9 million

$500 million - $999.9 million

$1 billion - $4.99 billion

$5 billion - $9.99 billion

Less than $100,000

30% 13% 16% 5%

$100,000-$500,000

58% 50% 50% 30%

$500,000-$1,000,000

5% 30% 19% 17%

$1 000,000-$1,500,000

7% 0 9% 28%

$1,500,000-$2,000,000

0 7% 3% 14%

Greater than $2,000,000

0 0 3% 6%