What can we expect of Board Directors?

Professor Blanaid ClarkeMcCann FitzGerald Chair of Corporate Law

Trinity College Dublin

ESRC People Risk Seminar, Dublin26 March 2014

The presentation will examine:• Our expectations of the role to be played by

directors

• Our expectations in terms of their qualificationand competences

• Will this improve the contribution of directors?

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I. BackgroundHard Law

- Statutory qualifications and duties of directors at national level

- Common law fiduciary duties

- Criminal Law sanctions

EU Corporate Governance Green Paper (2011), EU Company LawAction Plan (2012)

EU Commission Study on Directors’ Duties and Liability (2013)identified “gaps and deficiencies exist less with regard to thesubstantive rules on directors’ duties, and more in relation toenforcement”

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Soft Law

- EU Commission Recommendation on Strengthening the Roleof Non-Executive or Supervisory Directors (2005)

- National, International and transnational

Corporate Governance Codes (http://www.ecgi.org)

- A significant number of the changes have been implementedon foot of perceived corporate scandals

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Ireland

• Corporate Governance Code for Credit Institutions and Insurance Undertakings 2013

• Code of Practice for Good Governance of Community, Voluntary and CharitableOrganisations in Ireland 2012

• Corporate Governance Code for Collective Investment Schemes and ManagementCompanies 2011

• Corporate Governance Code for Irish Domiciled Collective Investment Schemes 2010

• Code of Corporate Governance for Independent Directors of Investment Funds 2010

• Corporate Governance Code for Credit Institutions and Insurance Undertakings 2010

• Irish Development NGOs Code of Corporate Governance 2008

• Corporate Governance for Reinsurance Undertakings 2007

• Corporate Governance, Share Option and Other Incentive Schemes 1999

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- The UK Corporate Governance Code 2012- The UK Stewardship Code 2012 - Corporate governance in central government departments: Code of good practice 2011

- Corporate Governance Guidance and Principles for Unlisted Companies in the UK 2010

- The AIC Code of Corporate Governance October 2010 - The UK Stewardship Code 2010 - The UK Corporate Governance Code 2010

- A Stewardship Code for Institutional Investors 2010 - The Audit Firm Governance Code 2010

- A review of corporate governance in UK banks and other financial industry entities (The Walker Review) 2009

- The Combined Code on Corporate Governance 2008 - Guidelines for Disclosure and Transparency in Private Equity 2007

- The Combined Code on Corporate Governance 2006 - Good practice suggestions from the Higgs Report 2006

- Internal Control: Revised Guidance for Directors on the Combined Code 2005

- Corporate governance in central government departments: Code of good practice 2005

- Pension Scheme Governance - fit for the 21st century: A Discussion Paper from the NAPF 2005

- Good Governance: The Code of Governance for the Voluntary and Community Sector 2005

- Corporate Governance: A Practical Guide 2004 - The Combined Code on Corporate Governance 2003

- Audit Committees - Combined Code Guidance (the Smith Report) 2003

- The Higgs Report: Review of the role and effectiveness of non-executive directors 2003

- The Responsibilities of Institutional Shareholders and Agents - Statement of Principles 2002 - The Hermes Principles 2002

- Review of the role and effectiveness of non-executive directors (Consultation Paper) 2002 - Code of Good Practice 2001

- The Combined Code: Principles of Good Governance and Code of Best Practice 2000 - Hermes Statement on International Voting Principles 1999

- The KPMG Review Internal Control: A Practical Guide 1999

- Internal Control : Guidance for Directors on the Combined Code (Turnbull Report) 1999

- Hampel Report (Final) 1998

- Greenbury Report (Study Group on Directors' Remuneration) 1995

- Cadbury Report (The Financial Aspects of Corporate Governance) 1992

RiskMetrics Study on Monitoring and Enforcement Practices in Corporate Governance in theMember States (2009)

• Overwhelming support for comply-or-explain regimefrom regulators, companies and investors

• Wide consensus it does not function perfectly

• Poor quality of company disclosure and insufficientexplanations

• Information on board and remuneration constitutes2/3 of all explanations for deviations

• Monitoring and enforcement remains problematic

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Influencing Factors

• Trend towards shareholder engagement

• Changes in corporate ownership andinvestment and trading practices

• Lessons from the Financial Crisis7

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Global Corporate Governance Failingsin Financial Institutions

• Risk Management and Internal ControlFailures

• Deficiencies in the Profile and Practice ofDirectors and Senior Management

• Perverse Incentives

• Failures in Disclosure and Transparency

• Complex and Opaque Corporate and BankStructures 9

II. Role of the Board• “Every public company should be headed

by an effective board which can bothlead and control the company”- CadburyCode (1992)

• “We expect [non-executive directors] tobehave as hard-nosed businessmen,referees, coaches, visionaries and saints,while giving only a few days a year to thejob”. (Economist, 1994) 10

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UK Corporate Governance Code 2012

• Every company should be headed by an effective board which is collectivelyresponsible for the long-term success of the company.

• The board’s role is to provide entrepreneurial leadership of the companywithin a framework of prudent and effective controls which enables risk tobe assessed and managed. The board should set the company’s strategicaims, ensure that the necessary financial and human resources are in placefor the company to meet its objectives and review managementperformance. The board should set the company’s values and standardsand ensure that its obligations to its shareholders and others areunderstood and met.

• The board is responsible for determining the nature and extent of thesignificant risks it is willing to take in achieving its strategic objectives. Theboard should maintain sound risk management and internal controlsystems.

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The Role of the Non-executive directors is:

• constructively challenge and help develop proposals on strategy

• scrutinise the performance of management

• monitor the reporting of performance

• satisfy themselves on the integrity of financial information

• ensure that financial controls and systems of risk managementare robust and defensible

• determine appropriate levels of remuneration of executivedirectors

• appoint/remove executive directors and engage in successionplanning

We expect [non-executive directors] to act as:

• Auditors

• Risk Experts

• Strategists

• Corporate Advisers

• Recruitment Advisers

• Public Servants

• Stewards

III. Board Composition

• “the calibre of the non-executive members ofthe board” (Cadbury Code, 1992)

• “The board and its committees should have theappropriate balance of skills, experience,independence and knowledge of the company toenable them to discharge their respective duties andresponsibilities effectively.”

• Sufficient time to discharge their responsibilitieseffectively.

• Information & Support• Development• Board Evaluation

CRD IV• “sufficiently good repute and possess sufficient

knowledge, skills and experience to perform theirduties”

• “act with honesty, integrity and independence of mindto effectively assess and challenge the decisions of thesenior management”

• “commit sufficient time to perform their functions”

(See also: The Corporate Governance Code for CreditInstitutions and Insurance Undertakings)

We expect [non-executive directors] to be:• Qualified• Experienced• Independent and bringing an independent judgement to bear• Committed• Available (i.e. limited other directorships)• Informed

• Challenging

• Interesting• Humorous

“In Ireland poor governance may well havebeen exacerbated by the concentratednature of corporate life where challengeand assertiveness in the Board room wasperhaps blunted by the social constraints

of working and living in a small businesscommunity in a small country.”

– Matthew Elderfield18

We expect Diversity in our BoardsUK Corporate Governance Code Principles

• There should be a formal, rigorous and transparent procedure for theappointment of new directors to the board.

• The search for board candidates should be conducted, and appointmentsmade, on merit, against objective criteria and with due regard for thebenefits of diversity on the board, including gender.

Provisions

• A separate section of the annual report should describe the work of thenomination committee, including the process it has used in relation toboard appointments. This section should include a description of theboard’s policy on diversity, including gender, any measurable objectivesthat it has set for implementing the policy, and progress on achieving theobjectives.

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Proposal for Gender Diversity Directive for Listed companies (excludingSMEs)- Binding Minimum Objective of 40% Women Non-Executive Directors by

2020- Appointments on basis of pre-established, clear, neutrally formulated

and unambiguous criteria- Positive discrimination for candidates of equal merit “unless an

objective assessment taking account of all criteria specific to theindividual candidates tilt the balance in favour of the candidate of theother sex”

Proposal for Directive to provide for Non-Financial and Diversity Reporting- ‘Comply or Explain’ requirement for large listed companies- Description in the Corporate Governance Statement of the Company's

diversity policy for its administrative, management and supervisorybodies covering:

• age, gender, geographical diversity and educational andprofessional background

• the objectives of the diversity policy• Manner of implementation and the results in the reporting period

Will these boards work?

House of Lords & House of Commons Parliamentary Commission on Banking Standards‘An accident waiting to happen’: The failure of HBOS

“I have no doubt that the HBOS Board was by far andaway the best board I ever sat on. My recollection of theculture and characteristics of the Board was one ofopenness, transparency, high intellect, integrity, goodworking relationships between the Chairman and ChiefExecutive, and a suitable diversity of backgrounds, mixof experience and expertise to maximise effectiveness[...] If with the benefit of hindsight I was asked if I wantedto sit on this board again I would be saying yes.” - SirRonald Garrick, Senior Independent Director, DeputyChairman

Parliamentary Commission on Banking Standards Conclusions

• The corporate governance of HBOS at board levelserves as a model for the future…It represents amodel of self-delusion, of the triumph of processover purpose.”

• “The Board made effective but supportivechallenges, as necessary, and would not seek tosecond guess executive management’sformulation of strategy.” – Board Assessment

Milgram (1974)

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8 Symptoms of Group-ThinkOverestimations of the Group1. Illusions of invulnerability2. Unquestioned belief in the morality of the groupClosed-Mindedness3. Rationalising warnings4. Sterotyping OpponentsPressures toward Uniformity5. Self-censorship of deviating ideas6. Illusions of unanimity among group members7. Direct pressure to conform8. Mind guards

Cognitive

Biases

Anchoring

Relative

PositioningFraming

Availability

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