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The Role of the
Board and the Appointment of Directors
(By Geoff Hines)
The appointment of a
director is a task faced by all companies from time to time, whether they be
large or small. However, for sizeable publicly owned corporations, it is a
crucial activity. When considering such an appointment the following questions
come to mind: -
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What is the role of
the board of directors?
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How is it different
from the role of the operating management committee?
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How many directors
should the company have?
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What should be the
ratio between executive and non-executive directors, between "insiders" and
"outsiders"?
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How should directors
be remunerated?
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How should directors
be selected?
New
legislation affecting the roles of directors together with recent company
failures have put increased emphasis on their responsibilities. A recent
publication of the prestigious U.S.A Business Round Table lists a number of
criticisms of Board of Directors:
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Directors do not
spend enough time on board work to be effective. They routinely attend
meetings, participate passively and collect a fee.
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Boards are handpicked
by the Chief Executive Officer and are therefore, submissive to him /her.
They are rubber stamps.
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Shareholders are
poorly informed on company matters and therefore poorly prepared for board
discussions.
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Boards are too
homogeneous. Directors are all cast from the same mould and therefore
will not 'rock the boat'!
Though these comments were
made in a North American context how pertinent are they to the situation that
exists in Australia today?
The Role of the
Board
The laws of the land
and the articles of association will define a number of specific board
responsibilities such as calling meetings of shareholders, the declaration
of dividends, the election and removal of officers, and the amendment of the
articles of association. These specific responsibilities are
straightforward and well understood. They have a strong legal and financial
basis and that is why accountants and lawyers are strongly represented on
most boards of directors. Though it is obviously very difficult to
generalise about the exact responsibilities of an individual board,
nevertheless, it is important to distinguish between its role and the role
of the operating management committee. In many companies there is often
confusion between these two separate and distinct activities and if these
are not clarified it can lead to dissatisfaction amongst senior executives
of the Company. The U.S.A. Business
Round Table lists four main functions of the Board (apart from the specific
legal and financial responsibilities). These are: -
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Management and
Board Selection and Succession.
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Corporate Actions
and Decisions with Potential for Major Economic Impact.
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Corporate Social
Responsibility.
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Compliance with
Law.
These four functions are not seen as exhausting the board’s responsibilities
but as being the central continuing elements of the board’s role.
Management and
Board Selection and Succession
One of the most
important, if not the most important, role of the board is with regard to
management succession. It has a prime responsibility in selecting the chief
executive officer and if necessary, in arranging his/her dismissal, as well
as in the placement of the other top executives of the company. In this
context it is important that plans have been made for orderly succession to
meet expected retirements and resignations as well as meeting emergencies
and unanticipated crises.
This role should not be
confined to the selection of operational management but also be involved in
the orderly succession to board positions. In particular, it is important
to plan for a balanced board so that a wide range of skills and experience
are available around the boardroom table.
Corporate
Actions and Decisions with Potential for Major Economic Impact
The day-to-day
management of the business should clearly be left to the chief executive
officer and the operational management of the enterprise. However, the
board has a major responsibility for the overall financial performance of
the company and will require regular reports on the financial results of the
business. In this regard the investment performance of superannuation funds
should not be over-looked. But the board’s responsibilities extend far
beyond this monitoring role since these should be a system in operation that
ensures prior board approval before any major commitment of corporate
resources. All of these decisions should be part of a wider strategic
corporate plan for the enterprise, which takes into, account projected cash
flow and overall corporate financial capability. Strategic planning,
therefore, and as part of it the review of business objectives, becomes the
foundation stone of this responsibility.
Corporate
Social Responsibility
This is the
consideration of the social impact of corporate activities on other
substantial groups (apart from shareholders) who may be significantly
affected by such activity. Nowadays it is becoming increasingly difficult
to direct the activities of a substantial business without some
consideration of the political and social environment in which the company
is operating. This is not to say that boards of directors should become
dewy-eyed philanthropists and divert the corporation’s dollars to their own
pet charities. Corporate social responsibility is very hard headed and is a
realization that shareholders and directors a like have a vital interest in
ensuring that their companies behave as good corporate citizens since this
will ensure their corporate long-term survival. Nevertheless it should be
emphasized that the corporation’s major corporate social responsibility is
to survive in the short term and make a profit. It would be socially
irresponsible to do otherwise.
Compliance with Law
As time goes by the
law has had a greater and greater impact upon companies and how they conduct
their business. This stems from the increased complexity of business, the
major social and political impact of business decisions, and the
preponderance of governments, whether Federal, State or local, to interfere
and control the business environment. The legal and regulatory requirements
placed upon companies nowadays are numerous, wide-ranging, sometimes obscure
and complex. Some of these laws and regulations have come into being as a
result of pressure from sections of the business community, despite at the
same time calling for a belief in a free enterprise system.
Obviously the board of
directors, despite the maze and the labyrinth of laws and regulations, will
want to ensure that there are policies and procedures in place which have
been designed to ensure compliance with the law. In this connection the
importance of policies and procedures to identify and deal with management
conflicts of interest cannot be overstressed.
Nevertheless despite
good and proper policies and procedures in this area there is no real
substitute for the individual integrity and sense of professionalism of the
managers in the business. Added to this is the importance of mutual trust
and understanding between the board and top management of the company.
Selection
So how does a company
select a new director? The first question one needs to determine is whether
the appointment should be made from inside or outside the organisation. The
answer to this will obviously depend upon the current composition of the
board and the philosophy with regard to inside and outside appointments.
There are two extreme views on this question. On the one hand it is argued
that all directors should be executives of the company since it is only by
working full-time for the organisation in a managerial capacity can an
individual really appreciate and understand the complexities of running a
modern business. Opposed to this is the view that all directors should be
non-executives, people who devote their main efforts to other pursuits,
since they are not emotionally involved in the day-to-day running of the
business and can therefore provide amore objective viewpoint in the
boardroom. They can provide against insularity and lack of vision.
As with most
situations of this kind we should reject both extremes and in other places
in the world, in the U.S. in particular, there is a strong tendency to move
towards a board structure based on a majority of outside directors, since
these will have no immediate accountability for short term financial results
and can provide a better focus on longer-range corporate interests. In
addition it must be emphasized that the board should be a balance between a
number of different backgrounds both from inside and outside the company.
It
should be noted that it is very desirable to use non-executive directors in
such critical areas as audit, executive compensation and management
succession where they may serve on committees of the board. It is these
important and vital activities that should be carried out be people who have
neither a pecuniary interest nor a prior involvement in the matters they are
reviewing or resolving.
So where do outside directors come from and
how do you find them? Do you limit the selection short-list to friends and
acquaintances of the chairman and other board members? Do you find another
accountant or lawyer with the time to spare? Or having analysed the
situation do you go out and search for someone with the qualities and
experience required to provide a balanced board?
Our earlier discussion on the role of the
board suggests that the qualities of a director should be integrity,
independence, an inquiring mind, vision, an ability to work with others, and
broad experience. The overall effectiveness of the board will depend upon
the collective strength of its membership and not just the individual
qualities. However the broader the range of views expressed in the
boardroom the more likely that the ultimate decisions made will be in the
best long-term corporate interest. In view of the particular nature of a
business enterprise a managerial position in another business is a
particularly relevant background for a director. It is invaluable for a
chief executive officer and the senior group of executives to have a central
core of experienced business executives on the board with whom they may
consult as necessary. However, it is also important to have a mix of
backgrounds to achieve the balance and breadth of experience required and
therefore it will be necessary to look for candidates from the professions,
consultancy, the academic world, and public life as well.
The selection process is an analytical one
with clearly defined stages –
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Agree on the role of the board in your
organisation and in particular the differences between the role of the
board and the role of the operating management committee. Agree
the qualities required in terms of skill, knowledge and ability required
to meet the needs of the role.
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Analyse the current membership of the
board in terms of skill, knowledge and ability.
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Compare the results from (2) with (1)
to give you a profile of your next board members
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Search for a short-list of three people
who meet the specification required so that a choice of candidates can
be presented to the board or a committee of the board for them to choose
someone who would be compatible.
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Use all the techniques available to you
as in executive recruitment e.g. advertising or search methods, to help
you complete your task.
Remuneration of Directors
The subject of directors’ remuneration can
often be an emotional topic at annual general meetings. However, in
Australia there is no real evidence that directors are overpaid for the
responsibilities that they undertake. If anything the opposite is the
case. There would be a number of companies that are compensating their
non-executive directors at a rate significantly lower than the daily rate
they would expect to pay a good consultant. If the company expects their
board to not only attend board meetings, board committee meetings, company
functions and visits but also to prepare in advance for such occasions, then
the board should be remunerated accordingly. Conversely, if the
remuneration is correct then the performance of the director must be
likewise.
Directors’
remuneration can be fixed by similar techniques that are used in executive
compensation programmes using salary reports and comparisons with daily
rates paid to professional consultants.
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