Chapter 4: Board of Directors Roles and Responsibilities PDF

Roles and Responsibilities of Corporate Governance Participants Chapter 4: Board of Directors Roles and Responsibilities  Introduction  Board of directors (BODs) is elected by shareholders to oversee the managerial function. Theoretically, the BOD exists to resolve the...

Roles and Responsibilities of Corporate Governance Participants Chapter 4: Board of Directors Roles and Responsibilities  Introduction  Board of directors (BODs) is elected by shareholders to oversee the managerial function. Theoretically, the BOD exists to resolve the agency problems associated with the separation of a company’s ownership controls from decision controls.  Intuitively, although directors are elected to align management’s interests with those of shareholders, their close association with the company’s senior executives can create conflicts of interest within the boardroom.  Senior executives, particularly CEOs, are motivated to take over the board by influencing the election of directors and controlling their compensation, whereas directors have the fiduciary duty to maintain their independence, monitor the CEO, and discipline the CEO for poor performance.  Chapter Objectives Identify the difference between decision management and decision control. Understand the role of the board of directors with regard to decision control and fiduciary duties. Understand that the board of directors is ultimately responsible for the business and its affairs. Provide an overview of what the oversight function entails. Identify and explain the fiduciary duties of the board of directors.  Chapter Objectives Identify the board attributes that affect the quality of monitoring and oversight functions performed by the company’s board. Illustrate the importance of an independent board of directors.  Role of the Board of Directors Decision Management, which consists of initiation and implementation of strategies, is viewed as the management’s responsibility, whereas decision control, which entails the ratification (confirmation) and monitoring of strategies, is viewed as the board of directors’ fiduciary duty performed on behalf of the shareholders. In performing their oversight function, boards of directors should not involve themselves in managerial and operational decisions through micromanaging. They should oversee managerial strategies but not implement them. In today’s ever-changing and challenging business environment, the traditional model of the BOD in just overseeing financial activities and reporting may not be adequate as directors get involved more in corporate governance functions of ensuring their company is prepared to meet future challenges.  Role of the Board of Directors The board of directors is ultimately responsible for the company’s business affairs and governance as stated in its governing documents, including the articles of incorporation, the bylaws, and shareholder agreements. Many state laws require a corporation to form a board of directors to represent shareholders and make decisions on their behalf. The success of the board of directors depends on the composition, structure, resources, diligence, and authority of the entire board, as well as its working relationships with other participants of corporate governance, including management, external auditors, internal auditors, legal counsel, professional advisors, regulators, standard-setting bodies, and investors. Role of the Board of Directors Role of the Board of Directors  Roles and responsibilities of boards of directors are to: (1) Represent shareholders and create shareholder value. (2) Align the interests of management with those of shareholders while protecting the interests of other stakeholders (customers, creditors, suppliers). (3) Define the company’s mission and goals. (4) Establish or approve strategic plans and decisions to achieve these goals. (5) Appoint senior executives to manage the company in accordance with the established strategies, plans, policies, and procedures. (6) Oversee the company’s performance by setting objectives, establishing short-term and long-term strategies to achieve these objectives, and assessing the performance of senior executives in fulfilling their responsibilities without micromanaging. (7) Approve major business transactions and corporate plans, decisions, and actions according to the bylaws. (8) Develop and approve executive compensation, pension, postretirement benefits plan, and other long-term benefits, including stock ownership and stock options. (9) Review financial reports, including audited annual financial statements, quarterly reviewed financial statements, and other important financial disclosures such as management discussion and analysis (MD&A) earnings releases and reports filed with regulators (SEC) or disseminated to the public. (10) Review management’s report on the effectiveness of internal control over financial reporting.  Roles and responsibilities of boards of directors are to: (11) Provide counsel to the company’s senior executives, especially the CEO, on material strategic decisions and risk management. (12) Ensure the company’s compliance with applicable laws, rules, and regulations. (13) Approve the company’s major operating, investing, and financial activities. (14) Set the tone at the top by promoting legal and ethical conduct throughout the company. (15) Evaluate the performance of the board, its committees (e.g., audit, compensation, and nominating), and the members of each committee. (16) Hold the board, its committees, and directors accountable for the fulfillment of the assigned fiduciary duties and oversight functions. (17) Approve dividends, financing, capital changes, and other extraordinary corporate matters (e.g. merger and acquisition). (18) Oversee the sustainability of the company in creating long-term shareholder value and protecting interests of other stakeholders.  Fiduciary Duties of the Board of Directors Fiduciary duty means that, as shareholders’ guardians, directors must be trustworthy, acting in the best interest of shareholders, and investors in turn have confidence in the directors’ actions. MANDATED BY LAW AND SPECIFIED IN COMPANIES CHARTERS AND BYLAWS The corporate governance literature presents the following fiduciary duties of boards of directors: 1. Duty of Due Care. 2. Duty of Loyalty. 3. Duty of Good Faith. 4. Duty to Promote Success. 5. Duty to Exercise Diligence, Independent Judgment, and Skill. 6. Duty to Avoid Conflicts of Interest. 7. Fiduciary Duties and Business Judgment Rules. Fiduciary Duties of the Board of Directors Fiduciary Duties of the Board of Directors  Fiduciary Duties of Board of Directors Duty of Due Care : determines the manner in which directors should carry out their responsibilities. Failure to uphold the set stipulations may constitute a breach of the fiduciary duty of care of expected directors. Duty of Loyalty : requires directors to refrain from pursuing their own interests over the interests of the company. Breach of loyalty can occur even in the absence of conflicts of interest if directors consciously disregard their duties to the company and its shareowners. Duty of Good Faith : Its an important element of directors fiduciary obligations, and any irresponsible, reckless, irrational or disingenuous (deceptive) behavior or conduct can breach this fiduciary duty. Duty to Promote Success: directors should act in a good faith and promote the success of the company for the benefit of its shareholders and other stakeholders. The directors‘ responsibilities include: approving the establishment of strategic goals, objectives and policies that promote enduring shareholders value as well as other stakeholder value protection.  Fiduciary Duties of Board of Directors Duty to Exercise Due Diligence, Independent Judgment, and Skill: The ultimate decision making responsibilities rest with the company′s BOD. Directors should be knowledgeable about the companies’ business and affairs, continuously update their understanding of the company activities and performance, and use reasonable diligence and independent judgment in making decisions. Duty to Avoid Conflicts of Interest: potential conflicts of interest may occur when a director receives a gift from a third party that is doing business with the company, either directly or indirectly enters into a transaction or arrangement with the company, obtains substantial loans from the company, or engages in backdated stock options. Fiduciary Duties of Board of Directors  Board Committees Operationally, the oversight function of corporate governance is typically performed by the company's board committees. BODs performs its oversight function through well structured, preplanned, and assigned committees in order to take advantage of the expertise of all the directors. Board committee formations and assignments depend on the size of the company, its board, and assumed responsibilities. Committee members address relevant issues and make recommendations to the entire board for final approval.  Board Committees Board committees normally function independently from each other, are provided with sufficient resources and authority, and are evaluated by the board of directors. Thus, board committees are a subset of the board and perform specific functions that assist the board in discharging its advisory and oversight responsibilities. Public companies usually have the following board committees: Audit committee. Compensation committee. Governance committee. Nominating committee. Disclosure committee. Other standing (continuance) or special committee.  Board Committees Audit Committee – composed of at least three independent directors should be formed to implement and support the oversight function of the board, specifically in the areas related to internal controls, risk management, financial reporting, and audit activities. Compensation Committee – composed of at least three independent directors serves to design, review, and implement directors’ and executives’ compensation plans. Governance Committee – consists of both executives and nonexecutives directors; should be established to advise, review, and approve management strategic plans, decisions, and actions in effectively managing the company.  Board Committees Nominating Committee – composed of at least three independent directors should be formed to monitor issues pertaining to the recommendation, nomination and election activities of directors. Disclosure Committee – this committee is usually led by corporate counsel, CFOs, or controllers. It is responsible for reviewing and monitoring the company’s 10-K, 10-Q, and other SEC filings, earnings releases, materiality issues, conference call scripts, and presentations to investors by senior management. Other Standing or Special Committee – the board of directors may form special committees to assist the board in carrying out its strategic and oversight functions, including financing, budgeting, investment, mergers and acquisitions.  Board Characteristics Board Leadership – The BODs is required to meet regularly to discuss the company′s business affairs and financial reports with or without the presence of management. The effectiveness of board meetings depends largely on the leadership ability of the chairperson to set an agenda and direct discussions. The board agenda is usually prepared by chairperson in collaboration with the CEO. CEO Duality – Implies that the company’s CEO holds both the position of chief executive and the chairman of the board of directors. There are pros and cons of that model, but investors usually prefer to separate the two positions. If they aren’t, then it is preferable that the company’s board should consist of a ‘substantial’ majority of independent directors.  Board Characteristics Lead Director – Demand for lead director increased because of the presence of CEO duality, resulting from growing concern that duality places too much power in the hands of CEO, which may impede board independence. Board Composition – In terms of the ratio of outside to inside directors, and the number of directors influences the effectiveness of the board. A board size of nine to fifteen directors is considered to be adequately tailored to the number of board standing committees, the size of the company, and the extent of its operations. Board Authority – Is granted through shareholder elections. SOX substantially expanded the authority of directors, particularly audit committee members, as being directly responsible for hiring, firing, compensating, and overseeing the work of the companies’ independent auditors.  Board Characteristics Responsibilities – The primary responsibility of the board of directors is that the company′s assets are safeguarded and the managerial decisions and actions are made in a manner of maximizing shareholders wealth while protecting the interests of other stakeholders. Resources – Board of directors should have adequate resources to effectively fulfill its oversight functions. Resources available to the board consist of legal, financial, and information resources. Board Independence – Implies that to be independent, a director shouldn’t have any other relationships with the company other than his or her directorship that may compromise the director’s objectivity and loyalty to the company′s shareholders.  Board Characteristics Director Compensation – Best practices suggest that any increases in stock ownership, reductions in cash payments, and charges in compensation should be aligned with shareholders′ long-term interest determined by the board, approved by shareholders, and fully disclosed in public reporting.