Corporate Governance and Board Duties

Roles and Responsibilities of Corporate Governance Participants

• Board of directors (BODs) are elected by shareholders to oversee the managerial function.
• BODs exist to resolve agency problems that arise from separating a company's ownership controls from decision controls.
• Directors are elected to align management's interests with shareholders' interests, but close association with senior executives can create conflicts of interest.
• Senior executives, particularly CEOs, are motivated to influence the election of directors and control their compensation, while directors have the fiduciary duty to maintain their independence, monitor the CEO, and discipline them for poor performance.

Chapter Objectives

• Identify the difference between decision management and decision control.
• Understand the role of the board of directors regarding decision control and fiduciary duties.
• Recognize that the board is ultimately responsible for the business and its affairs.
• Provide an overview of the oversight function.
• Identify and explain the fiduciary duties of the board of directors.
• Identify board attributes that affect monitoring and oversight functions.
• Illustrate the importance of an independent board of directors.

Role of the Board of Directors

• Decision Management involves initiating and implementing strategies, which is the management's responsibility.
• Decision control involves the ratification and monitoring of strategies, which is the board's responsibility on behalf of shareholders.
• Boards of directors should oversee managerial strategies without micromanaging.
• The traditional model of the BOD in just overseeing financial activities and reporting may not be adequate in a challenging business environment.
• The board is ultimately responsible for the company's business affairs and governance as stated in governing documents.
• State laws require boards of directors to represent shareholders and make decisions on their behalf.
• Board success depends on the composition, structure, resources, diligence, and authority of the entire board and its working relationships with other participants in corporate governance.
• The board may delegate decision-making authority to top management, but retains ultimate responsibility for the company.
• Boards represent stakeholders, not just shareholders.
• The board of directors is the cornerstone of corporate governance, safeguarding shareholders and other stakeholders' interests.

Roles and Responsibilities of Boards

• Represent shareholders and create shareholder value.
• Align management's interests with shareholders and other stakeholders (e.g., customers, creditors, suppliers).
• Define the company's mission and goals.
• Establish or approve strategic plans and decisions to achieve those goals.
• Appoint senior executives to manage the company.
• Oversee corporate performance by setting objectives, establishing strategies, assessing executive performance (without micromanaging).
• Approve major business transactions and corporate plans, decisions, and actions.
• Develop and approve executive compensation, pensions, benefits plans, stock options.
• Review financial reports (audited annual statements, quarterly reviews, disclosures).
• Review management's report on the effectiveness of internal controls over financial reporting.
• Provide counsel to senior executives, especially the CEO, on strategic decisions and risk management.
• Ensure the company's compliance with applicable laws, rules, and regulations.
• Approve major operating, investing, and financial activities.
• Establish a tone of legal and ethical conduct throughout the company.
• Evaluate the performance of the board, its committees, and members of the committees.
• Hold the board, committees, and directors accountable for fulfilling fiduciary duties and oversight functions.
• Approve dividends, financing, capital changes, and extraordinary corporate matters.

Fiduciary Duties of the Board

• Fiduciary duty means acting as shareholders' guardians, with trustworthiness and acting in their best interests.
• The corporate governance literature identifies fiduciary duties.
  • Duty of Due Care.
  • Duty of Loyalty.
  • Duty of Good Faith.
  • Duty to Promote Success.
  • Duty to Exercise Diligence and Skill, and Independent Judgment.
  • Duty to Avoid Conflicts of Interest.
  • Fiduciary Duties and Business Judgment Rules.
• The duty of due care determines how directors fulfill responsibilities.

Fiduciary Duties and Business Judgment Rules

• Directors operate under the business judgment rule, where decisions made in good faith, with rational reasoning, and in an informed manner, can protect them from shareholder liability (in the absence of fraud or gross negligence).
• Directors have discretion to make decisions and carry out fiduciary duties (due care, obedience, and loyalty) without legal challenges if those actions meet reasonable standards and the company's best interests.
• Directors can rely on information provided by management.
• Courts generally do not interfere with a director's actions unless those actions are not in good faith, are based on grossly negligent behavior or misconduct.

Board Committees

• Operational oversight is typically performed by the board committees.
• Committees are well-structured, preplanned, and assigned with appropriate expertise to take advantage of all directors' expertise.
• Board committee formations and assignments depend on the company size and responsibilities.
• Committee members address relevant issues and make recommendations to the board for approval.
• Committees function independently, are resource sufficient, and evaluated by the board of directors
• Public companies typically have audit, compensation, governance, nominating, disclosure committees; other standing or specialized committees are possible.

Board Characteristics

• Board Leadership: The board meets regularly to discuss the company, financial reports, and (sometimes management). Board meetings effectiveness depends on the chairperson's leadership abilities in setting an agenda and directing discussions.
• CEO Duality: implies a CEO of both the position of chief executive and the chairman of the board of directors. Investors often favor separating these roles.
• Lead Director: the presence of a lead director increases because of growing concerns on CEO duality and the power concentrated in the CEO role.
• Board Composition: The ratio of inside and outside directors (and the size of the board). Board sizes of 9 to 15 directors and sufficient committees are appropriate.
• Board Authority: granted through shareholder elections and further enhanced by the Sarbanes-Oxley Act (SOX), providing authority to directors, especially audit committees over independent auditors.
• Responsibilities: The primary responsibility of the board is safeguarding company assets and maximizing shareholder wealth while protecting other stakeholders' interests. Resources: boards must have legal, financial, and information resources.
• Board Independence: directors should have no other relationship with the company other than the directorship to avoid compromising objective decision-making.
• Director Compensation: Best practices suggest that increases in stock ownership, compensation reductions, and changes should align with shareholder long-term interests.