Corporate Governance & Role of BOD
As an outcome of the global financial crisis and numerous corporate scandals, companies are in need of most effective, skillful and honest board team more than ever. A dexterous squad of people, who fully understand and actively engage in virtually all aspects of a company’s operations and provide a useful insight in the decision making process. In theory, the board of directors plays a vital role in the corporate governance mechanism. Primary responsibilities of the board of directors are to foster a company’s long-term success and monitor its overall practices.
Essentially, it is formed to curb myopic actions of management that may be detrimental to long-term objectives of a corporation. Under the State corporate law, the duties of the board are embodied by the principle of fiduciary duty, which consists of: The “duty of care” requires that directors make decisions with due deliberation. Directors are required to exercise their powers with competence (or skill) and diligence in the best interests of the corporation. Hence, the duty of skill and diligence must be performed to a certain “standard of care”.
The “duty of loyalty” requires that the directors should act “in the interest of the corporation” and act as a governing body over
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In essence, the board of directors has basically a dual mandate: Advisory: To establish basic objectives, to consult and counsel the management regarding strategic and operational direction of the company. Supervisory: To monitor company’s performance and reduce agency costs. The board should ensure that the corporation has well-defined and protected shareholder rights, a solid control environment, high levels of transparency and disclosure. It must keep the interests of the company and those of all shareholders and stakeholders aligned.
Besides these, in the state FINN 383 |2 Role of Directors in Modern Corporation of emergency or crisis situation, (i. e. if the CEO dies or is incapacitated or the performance of the CEO is unacceptable) the boards need to take charge and play vital decision making role that requires change and improvement in current management. The board is responsible for directing and controlling the business of its company and is accountable to shareholders for its performance. However, these roles and independent performances exist merely in theory.
In reality, the situation is not as fancy as shown in the literature. Boards’ roles are very much constrained, where the CEO plays significant backstage role and directors do nothing but just to act as his marionettes. Unfortunately, boards seldom show any interest in the operations of the company. They are too busy to actively participate in the corporations’ decision making processes or attend the board meetings vigorously. Hence, authorities suggest that the boards should take a proactive role rather than a passive one by facilitating the management in achieving the goals set by the investors, approving managements’ actions, taking part in strategic decision making actively, giving advice, holding them accountable and monitoring the performance of the company and management to safeguard the interests of all the stakeholders. Despite increased scrutiny and pressure on the boards to improve their performance, most of the boards in Modern Corporations are still struggling. Even when the boards are making conscious efforts to improve themselves, majority of them remain largely ineffective and inefficient. Read about Corporate Governance at Wipro
One of the root causes of this problem lie with the way boards are designed. The first step towards establishing a robust corporate governance mechanism is to establish a board that has “an optimal size and the appropriate balance of skills, experience, independence and acquaintance with the company to enable them to execute their respective duties and responsibilities effectively”. Leadership, mix of experience, skills and information flows must be aligned to responsibilities and tasks of the board.
Only when all these variables are aligned, the board will be able to effectively perform its duties and add greater value to the business. As suggested in Resource Dependency Theory, directors should be hired in such a way that they provide linkages to the external environment and essential skills such as business expertise, legal and financial skills. Diversity of skills and experience in the board is also critical as board members with diverse experiences and skills bring creative and out-of-the-box solutions to the issues at hand and unique problem solving techniques to the challenges faced by the company.
On the contrary, FINN 383 |3 Role of Directors in Modern Corporation we should not ignore the real time practical example of Enron which had well-experienced and diversified board with majority of external members yet failed to perform its fiduciary responsibility. It is important to recruit and develop directors who make sure internal governance mechanism is in place which goes well beyond the basic needs and this is basically the secret to build up a high-performing yet fully actualized board.
Another most critical point to consider while designing the board of a particular corporation is to create a balanced ratio of outside to inside directors. It is argued that outside directors have incentives to carry out their monitoring tasks and not to collude with top managers to expropriate stockholder wealth; hence, they act as true watchdogs over its operations. Therefore, the inclusion of outside directors increases the board’s ability to monitor top management effectively in agency settings arising from the separation of corporate ownership and decision control.
On the contrary, it is also contested that independent directors come with a string attached; they usually lack deeper understanding of the business operations and its dynamics. Furthermore, since they have to be informed about the company’s operations, they usually have to rely on the information being provided by the management which biases their view of the situation. This bias defeats the very purpose of independent directors and hence affects directors’ true role.
As an opinion, having a strictly independent board is not a solution but a balanced mix is required. The idea is to have some people in the board who have the necessary knowledge by being part of the industry or even being associated with the company. This concept of having people with relevant knowledge would make the board ask in-depth questions more rather than just asking superficial questions. More important is the commitment of the board members which would make a board effective and efficient.
It is assumed that the sole objective of the board should be to enhance shareholder’s value. Although, there is nothing wrong with this focus but if the corporation wants to stride up to the ladder and accomplish its long run objectives then boards are required to shift their focus from narrow to wider responsibilities towards other stakeholders too, such as the suppliers, customers, employees and the community within which it operates. Profit maximization for the shareholders at the expense of society (e. g. polluting the environment or spoiling the resources) would restrict board responsibilities to a very narrow focus. Boards have a responsibility of maximizing.
Role of Directors in Modern Corporation shareholders’ wealth, but they need to achieve this objective while keeping in mind the interests of other stakeholders as well as the long term sustainable value creation for the corporation. Although, now a days, the shareholder model of corporate governance is widely embedded in our part of corporate world.
However to attain optimal efficiency from the roles of management, control and supervisory, it is advised that they are to be treated and encouraged to adopt this role as stewards instead of the agents of corporation. Managers (accountable to directors) and directors (accountable to shareholders and corporation as a whole) are encouraged to adopt a role of the stewards, believe their interests are aligned with that of the corporation, have high identification with the organization and are more likely to take credit of success and responsibility of failures attached to the organization.
Hence, mutual steward relationship will lead to greater potential performance of a company. From the research, there is clear evidence to suggest that companies worldwide believe that representation of the management on the board enables a more substantive discussion to take place during board meetings and is in the best interest of the company and its shareholders. However, in these companies, the substantive powers to direct and control the companies lie with the executive management, and the role of the Supervisory Board is substantially more constrained.
Although, the rule says that boards are supposed to monitor management activities, make key strategic decisions and advise management, however, the extent to which directors can be involved in managing the company remains a debatable issue. Hence, it is important that the boards are provided with freedom and full authority over their job for the best outcomes in the interest of a corporation as a whole.
It is indeed vital for the corporations to have the governance structures that are effective and the directors are able to execute their roles independently irrespective of the risk of losing extrinsic benefits from the company’s CEO under his disguised control as marionette. A good performance should not lead to lax controls. Effective corporate governance is more complex and challenging than ever. Companies need boards to help them meet regulatory compliance basics. And the most effective boards are those that easily check that box, while also delivering solid strategic counsel and direction.